How Wells Fargo’s High-Pressure Sales Culture Spiraled out of Control” from The Wall Street Journal

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Chapter One
The Pay Model

Chapter Outline

Compensation: Does It Matter? (or, “So What?”)
Compensation: Definition, Please (Stakeholders)

Society
Stockholders
Customers
Managers
Employees

How Pay Influences Behaviors: Incentives and Sorting Effects

Global Views—Vive la Différence

Forms of Pay

Cash Compensation: Base
Cash Compensation: Merit Increases/Short-Term Incentives (Merit Bonuses)/COLAs
Cash Compensation: Incentives
Long-Term Incentives
Benefits: Income Protection
Benefits: Work/Life Balance
Benefits: Allowances
Total Earnings Opportunities: Present Value of a Stream of Earnings
Relational Returns from Work

A Pay Model

Compensation Objectives
Four Policy Choices
Pay Techniques

Book Plan
Caveat Emptor—Be an Informed Consumer

1. Is the Research Useful?
2. Does the Study Separate Correlation from Causation?
3. Are There Alternative Explanations?

Your Turn: Compensation at the World’s Largest Company
Still Your Turn: Who Are Amazon’s Peer Companies for Comparing Compensation?

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COMPENSATION: DOES IT MATTER? (OR, “SO WHAT?”) 

Why should you care about compensation? Do you find that life goes more smoothly when there is at least as much money coming in as going out? (Refer, e.g., to the lyrics for the Beatles’ song “Money.”1 To exaggerate a bit, they say something like: Money doesn’t buy everything, but if money can’t buy it, I can’t use it.) In the movie, It’s a Wonderful Life, George Bailey is in a difficult spot. An (inexperienced) guardian angel by the name of Clarence has been sent to help George. When Clarence implores George to let him help, George asks if he has $8,000 on him. Clarence replies “No, we don’t use money in Heaven” to which George responds: “Well, it comes in real handy down here, bud!”
Of course, it is the same for companies. It really does help to have as much money coming in (actually, more is better) as going out. Until recently, production workers at Chrysler received total compensation (i.e., wages plus benefits) of about $76 per hour. U.S. workers doing the same jobs at Toyota received $48 per hour, and the average total compensation per hour in U.S. manufacturing was $25 (and $3 in Mexico–not surprisingly, many new automobile supply and assembly plants have gone to Mexico in recent years). It is one thing to pay more than your competitors if you get something more (e.g., higher productivity and/or quality) in return. But Chrysler was not. So its “strategy” was not sustainable. Chrysler ended up going through bankruptcy, being bought out by Fiat, and then reducing worker compensation costs as part of its strategy for a return to competitiveness. Specifically, Chrysler took steps (as part of its bankruptcy plan) to bring its hourly labor costs down to about $49.2 (Fiat Chrysler is now part of Stellantis.)
General Motors (GM), like Chrysler, has for decades paid its workers well—too well, perhaps, for what it received in return. So what? Well, in 1970, GM had 150 U.S. plants and 395,000 hourly workers. In sharp contrast, GM now has 32 U.S. manufacturing plants (including 11 vehicle assembly plants) and 87,000 U.S. workers (up from 57,000 U.S. hourly workers a few years ago).3 In June 2009, GM, like Chrysler, had to file for bankruptcy (avoiding it for a while thanks to loans from the U.S. government—i.e., you, the taxpayer). Not all of GM’s problems were compensation related. Building too many vehicles that consumers did not want was also a problem. But having labor costs higher than the competition’s, without corresponding advantages in efficiency, quality, and customer service, does not seem to have served GM or its stakeholders well. Its stock price peaked at $93.62/share in April 2000. Its market value was about $60 billion in 2000. That shareholder wealth was wiped out in bankruptcy. Think also of the billions of dollars the U.S. taxpayer had to put into GM. Think of all the jobs that have been lost over the years and the effects on communities that have lost those jobs. (The good news is that as of 2021, GM’s market value was over $80 billion. However, that is a ways behind what is now the most valuable U.S. carmaker, Tesla, at $635 billion, depending on the day, or about 8x greater than GM.)
On the other hand, Nucor Steel pays its workers very well, relative to what other companies inside and outside of the steel industry pay. But Nucor also has much higher productivity than is typical in the steel industry. The result: Both the company and its workers do well. Apple Computer is able to charge lower prices for its iPads and iPhones by outsourcing manufacturing to China in facilities owned by the Hon Hai Precision Industry Co., Ltd. (Foxconn), a Taiwanese company. (See Chapter 7.) As we will see later, doing so generates billions (yes, billions with a “b”) of dollars in cost savings per year. Google and Facebook are companies that are known for paying very well. So far that seems to have worked, in that their high pay allows them to be very selective in who they hire and who they keep, and they would say that their talent-rich strategy has helped them to foster growth and innovation.
Wall Street financial services firms and banks used incentive plans that rewarded people for developing “innovative” new financial investment vehicles and for taking risks to earn a lot of money for themselves and their firms.4 But several years ago, during the Great Financial Crisis of 2008, the markets discovered that many page 4such risks had gone bad. Blue chip firms such as Lehman Brothers slid quickly into bankruptcy, whereas others, like Bear Stearns and Merrill Lynch, survived to varying degrees by finding other firms (J.P. Morgan and Bank of America, respectively) to buy them. The issue has not gone away. U.S. Federal Reserve officials have “made it clear that they believe bad behavior at banks goes deeper than a few bad apples and are advising firms to track warning signs of excessive risk taking and other cultural breakdowns.” In the words of one Fed official, “Risk takers are drawn to finance like they are to Formula One racing.” An important driver of risk taking among traders and others is the incentive system that encourages them to be “confident and aggressive” and that often results in those who thrive under this incentive rising to top leadership positions at the banks.5
Novartis is a health care solutions company based in Switzerland that includes medicines, pharmaceuticals, and eye care. The U.S. Justice Department announced a $678 million settlement with Novartis over improper inducements to persuade doctors to prescribe Novartis drugs, including Lotrel for hypertension. It is the largest whistleblower settlement under federal law. The key whistleblower was Ozzie Bilotta. According to NBC News, when he began working at Novartis, it was his dream job. But, “he never thought he’d be bribing doctors and wearing a wire for the feds.” He ended up taking this sort of “drastic action” because he felt it was necessary to change how the pharmaceutical industry operated. Novartis subsequently changed its sales compensation such that pay no longer depends only on sales. It also now depends on an evaluation of whether sales were achieved in a way that is consistent with the Novartis Code of Ethics. There is also an Anti-Bribery Policy document that includes directing employees to “Always ask yourself before offering, giving, or promising anything of value to any person if what you are considering could be viewed as having an illegitimate purpose. If the answer is yes, you must not proceed.”6 Novartis has also increased its investment in data collection and analytics to monitor compliance with its Code of Ethics.
How people are paid affects their behaviors at work (as we have seen, for good or bad), which affect an organization’s success.7 For most employers, compensation is a major part of total cost, and often it is the single largest part of operating cost. These two facts together mean that well-designed compensation systems can help an organization achieve and sustain competitive advantage. On the other hand, as we have recently seen, poorly designed compensation systems can likewise play a major role in undermining organization success.
Our book, we hope, can play a role in helping to better educate you, the reader, about the design of compensation systems, both for managers and for workers. That includes not only how compensation can make things work better, but just as importantly, how compensation can make things go wrong, sometimes very wrong, as in our above examples.

COMPENSATION: DEFINITION, PLEASE (STAKEHOLDERS)
How people view compensation affects how they behave. It does not mean the same thing to everyone. Your view will probably differ depending on whether you look at compensation from the perspective of a member of society, a stockholder, a manager, or an employee. Thus, we begin by recognizing different perspectives.
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EXHIBIT 1.1 Indicators of Economic Standard of Living, United States (all dollar amounts in constant $), by Year

aAdjusted for Purchasing Power, 2017 Dollars. Source: WorldBank. https://data.worldbank.org/indicator/SL.GDP.PCAP.EM.KD
bU.S. Bureau of Labor Statistics. Usual Weekly Earnings. Multiplied by 52 and converted to 2020 dollars.
c2017 Dollars. Source: Congressional Budget Office (2020). The Distribution of Household Income, 2017. October 2020. Transfers are means-tested (i.e., depend on income) and include, for example, Medicaid. Taxes are federal and include income tax, payroll tax, corporate, and excise tax.
https://www.cbo.gov/system/files/2020-10/56575-Household-Income.pdf
d2020 Dollars. Source: Board of Governors of the Federal Reserve (U.S.). Households and Nonprofit Organizations; New Worth, Level.
https://fred.stlouisfed.org/series/HNONWRA027N
ehttps://fred.stlouisfed.org/series/POPTOTUSA647NWDB
fEmmanuel Saez and Gabriel Zucman. The Rise of Income and Wealth Inequality in America: Evidence from Distributional Macro-economic Accounts. Journal of Economic Perspectives, 2020, 34, 3–26. Uses “tax units” (individuals) rather than households.

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Society
Exhibit 1.1 summarizes information on indicators of economic standard of living. All dollar amounts are in constant (also called real) dollars (i.e., adjusted for price changes/inflation). At the top, we start with Panel A, economic output (GDP) per Employed Person, a measure of national productivity. We see that productivity has increased by 52 percent since 1990. As a general rule, increases in productivity are necessary to generate increases in income and wealth for most of the population. We also note that the level of productivity in the United States in 2020, $127,378, is the highest among the 30 largest economies in the world. Panel B shows that (real) average annual earnings have increased 23 percent since 1990. Panel C moves from individual earnings from work to household income from all sources, including earnings, but other sources also (e.g., employer contributions for health care premiums, unemployment compensation, business income, capital income/gains, among others). We provide two sets of household income, before and after taxes (generally higher at higher income levels) and (means-test, meaning based on income) transfers (e.g., Medicaid; Children‘s Health Insurance Program; these transfers are generally higher at lower income levels). We see that income overall (All) has grown by 45 percent since 1990, before transfers and taxes and 51 percent after adjusting for taxes and transfers. Growth in economic output is the basis for growth in overall income (and wealth). However, the way income and wealth is distributed is also important. We show the income shares for page 7the top 1 percent of income group and for selected quintiles (each one-fifth of the distribution). We see that income of the top 1 percent in 2020, after transfers and taxes, was $1,343,000 and it has grown by 110 percent since 1990. In contrast, the other quintiles have income that is considerably lower in 2020 (e.g., 68,000 in the middle quintile) and, although their growth rates are positive and significant, ranging from 37 percent to 68 percent, their growth has been considerably lower than for the top 1 percent group. Finally, Panels D and E show household wealth and individual wealth, including shares at the top. Again, there is good news in that household wealth has grown substantially over time, nearly tripling from 1990 to 2020. In this case, we need to account for the fact that the population also grew. Clearly, however, population growth was much smaller, indicating that the wealth of Americans really has increased substantially over time. However, wealth is very concentrated. We see that the top 10 percent hold 77 percent of the country’s wealth and the top 1 percent hold 38 percent of its wealth. We also see that the concentration of wealth has increased since 1990.
The focus on the distribution of income and its implications for justice or equity is also seen in the attention paid to earnings differences by demographic groups.8 For example, a comparison of earnings between men and women highlights what many consider inequities in pay decisions. Among full-time, year-round workers in the United States, women earn 82 percent of what men earn (up from 60 percent in 1980).9 If women had the same characteristics as men, especially years and continuity of work experience and worked in the same occupations and industries, the gap narrows by one-half or more (see Chapter 17).10 However, even with that, women would earn 93 percent of what comparable men earn, thus still leaving a sizable gap. Society has taken an interest in such earnings differentials. One indicator of this interest is the introduction of laws and regulations aimed at eliminating the discrimination that causes them.11 (See Chapter 17.)
Based on the discussion above, it seems clear that people care greatly about their income. However, one well-known study on this issue by Kahneman and Deaton has sometimes been incorrectly (and/or incompletely interpreted) to mean that money only matters up to a point.12 For example, based on the study, $75,000 (let’s call it more like $95,000 adjusted for inflation) has been identified as the magic amount of annual income that makes people happy and paying them more had severely diminishing returns such that annual income beyond $75,000 did not increase their happiness any further. However, that result is based on asking people about the emotional well-being (“happiness) they experienced yesterday. Perhaps not surprisingly, having had a “headache” yesterday or reporting “zero social time with friends or family yesterday, including telephone and email-contact” had much larger effects on the emotional well-being/affect they felt yesterday than did whether their annual income was above $75,000. In contrast, when asked about life evaluation on a scale ranging from 0 (“worst possible life for you”) to 10 (“the best possible life for you”), there was almost no diminishing return to higher income (measured on a log scale, equivalent to using percentage increases in income). As Kahneman and Deaton put it, there is “a fairly steady rise in life evaluation” in proportion to increases in income “over the entire range.” Even returning to “happiness,” Deaton and Kahneman caution: “Our data speak only to differences; they do not imply that people will not be happy with a raise from $100,000 to $150,000, or that they will be indifferent to an equivalent drop in income.” In summary, the Deaton and Kahneman findings can be interpreted to mean, first, that increases in income that help people avoid poverty or the threat of poverty (or what is called financial precarity) have a major positive impact on both happiness and life evaluation. Second, these increases in income have diminishing returns for increasing happiness (as measured by emotional well-being the day before) beyond $95,000 in today’s dollars. Third, it would be a mistake to think that reducing anyone’s pay to $95,000 would do anything but make them unhappy. Fourth, higher pay is associated with higher life satisfaction and that association continues beyond $95,000.
Benefits given as part of a total compensation package, like wages/salaries, may also be seen as a reflection of equity or justice in society. As we will see, private sector employers spend about 42 cents for benefits on top of every dollar paid for wages and salaries. (State and local government employers pay even more: 62 cents in benefits on top of every wage dollar.)13 Individuals and businesses in the United States spend $3.6 trillion per year, or about 17 percent of U.S. economic output (gross domestic product) on health care.14 Nevertheless, page 8as we will see, many (over 30 million) of people in the United States (over 8 percent of the population) have no health insurance.15 (Prior to implementation of The Affordable Care Act of 2010, over 48 million were uninsured.)16 A major reason is that the great majority of people who are under the age of 65 and not below the poverty line obtain health insurance through their employers, but small employers, which account for a substantial share of employment, are much less likely than larger employers to offer health insurance to their employees. As a result, the great majority of uninsured in the United States are from working families. (Of the uninsured, 85 percent have a full-time worker in the family and another 11 percent have a part-time worker in the family.)17 Given that those who do have insurance typically have it through an employer, it also follows that whenever the unemployment rate increases, health care coverage declines further. (Some users of online dating services provide information on their employer-provided health care insurance. Dating service “shoppers” say they view health insurance coverage as a sign of how well a prospect is doing in a career.)
Job losses (or gains) within a country over time are partly a function of relative labor costs (and productivity) across countries. People in the United States worry about losing manufacturing jobs to Mexico, China, and other nations. (Increasingly, white-collar work in areas like finance, computer programming, and legal services is also being sent overseas.) Exhibit 1.2 reveals that annual salary cost per employee (these numbers do not include benefits) in Mexico is $17,594, or about one-quarter of the $65,836 average salary in the United States. China’s estimated annual salary of $12,430 is less than one-fifth of the U.S. rate. However, the value of what is produced also needs to be considered. Productivity in China is also roughly one-fifth that of U.S. workers, whereas Mexican worker productivity is about one-third of the U.S. level. Finally, if low wages are the goal, there always seems to be somewhere that pays less. Some companies (e.g., Coach) are now moving work out of China because its hourly wage, especially after recent increases, is not nearly as low as in countries like Vietnam, India, and the Philippines.18 However, for other companies—such as Foxconn, which builds iPhones and iPads for Apple—even with increases in wages in China, labor costs remain very low in China compared to those in the United States and other advanced economies. Foxconn appears to be poised to continue having a large presence in China, a part of the world where most of its supply chain is. However, recent events are leading it, like others, to work to diversify its production and supply chain to be less dependent on any one country. We return to the topic of international comparisons in Chapter 7 and Chapter 16.)
EXHIBIT 1.2 Annual Salary and Economy-Wide Productivity (Gross Domestic Product [GDP] per Employed Person), in U.S. Dollars

 
Annual Salary (excludes benefits)
Productivity (GDP per employee)

United States
65,836
127,378

Mexico
17,594
 45,172

Japan
38,617
 78,297

China
12,430
 30,074

Germany
53,638
105,234

Czechia
29,281
  81,079

Source: Annual salary (not including benefits) is from the Organization for Economic Cooperation and Development (OECD.org). https://data.oecd.org/earnwage/average-wages.htm, Salary data for China are from: Table 4-12, China Statistical Yearbook 2019. National Bureau of Statistics of China. http://www.stats.gov.cn/tjsj/ndsj/2019/indexeh.htm. Converted from yuan to USD using average exchange rate for 2019. Productivity is gross domestic product (GDP), in constant 2017 PPP $, divided by total employment in the economy. Purchasing power parity (PPP) adjustments are made to adjust for what can be purchased in different countries with the equivalent of a U.S. dollar. Source: The World Bank. https://data.worldbank.org/indicator/SL.GDP.PCAP.EM.KD.
Some consumers know that pay increases often lead to price increases. They do not believe that higher labor costs benefit them. But other consumers lobby for higher wages. While partying revelers were collecting plastic beads at New Orleans’ Mardi Gras, filmmakers were showing video clips of the Chinese factory that makes page 9the beads. In the video, the plant manager describes the punishment (5 percent reduction in already low pay) that he metes out to the young workers for workplace infractions. After viewing the video, one reveler complained, “It kinda takes the fun out of it.”19

Stockholders
Stockholders are also interested in how employees are paid. Some believe that using stock to pay employees creates a sense of ownership that will improve performance, which in turn will increase stockholder wealth. But others argue that granting employees too much ownership dilutes stockholder wealth. Google’s stock plan cost the company $600 million in its first year of operation. So people who buy Google stock (stockholders) are betting that this $600 million will motivate employees to generate more than $600 million in extra stockholder wealth.
Stockholders (also called shareholders) have a particular interest in executive pay.20 (Executive pay will be discussed further in Chapter 14.)21 To the degree that the interests of executives are aligned with those of shareholders (e.g., by paying executives on the basis of company performance measures such as shareholder return), the hope is that company performance will be higher. There is debate, however, about whether executive pay and company performance are strongly linked in the typical U.S. company.22 In the absence of such a linkage, concerns arise that executives can somehow use their influence to obtain high pay without necessarily performing well. Exhibit 1.3 provides descriptive data on chief executive officer (CEO) compensation. Note the large numbers (total annual compensation of $12.3 million) and also that the bulk of compensation (stock-related) is connected to shareholder return or other (primarily short-term, or one year or less) performance measures (bonus). As such, one would expect changes in CEO wealth and shareholder wealth to generally be aligned. We will return to this topic in more depth in Chapter 14.
EXHIBIT 1.3 Annual Compensation of Chief Executive Officers, U.S. (S&P 500) Public Companies

 
Median

Compensation Component
 

Salary
$ 1,200,000

Bonus
$ 2,000,000

Stock Grants
$ 6,500,000

Stock Option Awards
$ 0a    

Total Annual Compensation
 $ 12,300,000

aThe mean was $2.0 million.
Source: Equilar, CEO Pay Trends. Equilar.com. Because medians are used, compensation components do not add up to equal total annual compensation.
In Chapter 14 we will suggest that, on average, CEO interests and shareholder interests appear to be significantly aligned, but there are important exceptions and it is certainly an ongoing challenge to ensure that executives act in the best interest of shareholders. For example, during the meltdown in the financial services industry, top executives at Bear Stearns and Lehman Brothers regularly exercised stock options and sold stock during the period 2000–2008 prior to the meltdown. One estimate is that these stock-related gains plus bonus payments generated $1.4 billion for the top five executives at Bear Stearns and $1 billion for those at Lehman Brothers during the 2000–2008 period. “Thus, while the long-term shareholders in their firms were largely decimated, the executives’ performance-based compensation kept them in positive territory.” The problem here is that shareholders paid a huge penalty for what appears to have been overly aggressive risk-taking by page 10executives, but the executives, in contrast, did quite well because of “their ability to claim large amounts of compensation based on short-term results.”23
Shareholders can influence executive compensation decisions in a variety of ways (e.g., through shareholder proposals and election of directors in proxy votes). In addition, the Dodd–Frank Wall Street Reform and Consumer Protection Act (see Chapter 14) was signed into law in 2010. Among its provisions is “say on pay,” which requires public companies to submit their executive compensation plan to a vote by shareholders. The vote is not binding. However, companies seem to be intent on designing compensation plans that do not result in negative votes. In addition, clawback provisions (designed to allow companies to reclaim compensation from executives in some situations) are available under Dodd–Frank and have also been adopted in stronger form by some companies.24

Customers
Employment costs in the form of compensation are often the largest single operating cost for an organization. Thus, for companies whose business strategy depends on low product/service cost to compete for customers, they also may focus on keeping compensation costs low. As we will see shortly, that is certainly true of Walmart. It certainly seems to have worked in the eyes of customers as it is year after year the largest company in the world in terms of revenues. As a different example, we will see that Costco’s business strategy is less exclusively cost-based. They are concerned about employment costs, but their business strategy depends on paying higher wages to attract and retain employees more successfully than Walmart does, as well as employees who can provide a higher level customer experience. Compensation also increasingly comes into play for customers who want to purchase from a company that acts with responsibility with respect to environmental, social, and governance (ESG) issues. This can take a variety of forms in the employment and compensation area. For example, customers may base their buying decisions on how they believe the company’s employees are treated and/or how workers employed by other companies, but part of the company’s supply chain, are treated. For example, Apple has supplier responsibility standards and an extensive system to monitor supplier adherence to these standards, including in the area of employment.25

Managers
For managers, compensation influences their success in two ways. First, it is a major expense that must be managed. Second, it is a major determinant of employee attitudes and behaviors (and thus, organization performance). We begin with the cost issue. Competitive pressures, both global and local, force managers to consider the affordability of their compensation decisions. Labor costs can account for more than 50 percent of total costs. In some industries, such as financial or professional services and in education and government, this figure is even higher. However, even within an industry, labor costs as a percentage of total costs vary among individual firms. For example, small neighborhood grocery stores, with labor costs between 15 percent and 18 percent, have been driven out of business by supermarkets that delivered the same products at a lower cost of labor (9 to 12 percent). Supermarkets today are losing market share to the warehouse club stores such as Sam’s Club and Costco, which enjoy an even lower cost of labor (4 to 6 percent), even though Costco pays wages that are above average for the industry. And, now Amazon has entered the grocery business by purchasing Whole Foods, which is expected to cause further cost reductions and disruption.
Exhibit 1.4 compares the hourly pay rate for retail workers at Costco to that at Walmart and Sam’s Club (which is owned by Walmart). Wages for the three jobs in Exhibit 1.4 are higher at Costco. The Costco wages are increasing further because as of 2021, its minimum wage will go to $16/hour. Walmart’s minimum wage remains at $11/hour. Each retailer tries to provide a unique shopping experience. Walmart and Sam’s Club compete on low prices, with Sam’s Club being a “warehouse store” with especially low prices on a narrower page 11range of products, often times sold in bulk. Costco also competes on the basis of low prices, but with a mix that includes more high-end products aimed at a higher customer income segment. To compete in this segment, Costco appears to have chosen to pay higher wages, perhaps as a way to attract and retain a higher quality workforce.26 A Costco’s annual report states, “With respect to expenses relating to the compensation of our employees, our philosophy is not to seek to minimize the wages and benefits that they earn. Rather, we believe that achieving our longer-term objectives of reducing employee turnover and enhancing employee satisfaction requires maintaining compensation levels that are better than the industry average for much of our workforce.” By comparison, Walmart simply states in a previous annual report that they “experience significant turnover in associates [i.e., employees] each year.”27 Based on Exhibit 1.4, Costco is quite successful, relative to its competitors, in terms of employee retention, customer satisfaction, and the efficiency with which it generates sales (see revenue per square foot and revenue per employee). So, although Costco’s labor costs are higher than those of Sam’s Club and Walmart, it appears that this model works for Costco because it helps it gain an advantage over its competitors.
Thus, rather than treating pay only as an expense to be minimized, a manager can also use it to influence employee behaviors and to improve the organization’s performance. High pay, as long as it can be documented to bring high returns through its influences on employees, can be a successful strategy. As our Costco (versus Sam’s Club and Walmart) example seems to suggest, the way people are paid affects the quality of their work and their attitude toward customers.28 It may also affect their willingness to be flexible, learn new skills, or suggest innovations. On the other hand, people may become interested in unions or legal action against their employer based on how they are paid (e.g., if they perceive their pay to be unfairly low). This potential to influence employees’ behaviors, and subsequently the productivity and effectiveness of the organization, means that the study of compensation is well worth your time, don’t you think?29

Employees
The pay individuals receive in return for the work they perform and the value they create is usually the major source of their financial security. Hence, pay plays a vital role in a person’s economic and social well-being. Employees may see compensation as a return in an exchange between their employer and themselves, as an entitlement for being an employee of the company, as an incentive to decide to take/stay in a job and invest in performing well in that job, or as a reward for having done so. Compensation can be all of these things.30
The importance of pay is apparent in many ways. Employees are less likely to quit current jobs that pay more and are likely to increase their pay when they quit voluntarily to take another job. (See Chapter 7.) Wages and benefits are a major focus of labor unions’ efforts to serve their members’ interests. (See Chapter 14.) The extensive legal framework governing pay—including minimum wage, living wage, overtime, and nondiscrimination regulations—also points to the central importance of pay to employees in the employment relationship. (See Chapter 17.) Next, we turn to how pay influences employee behaviors.

HOW PAY INFLUENCES BEHAVIORS: INCENTIVE AND SORTING EFFECTS
Pay can influence employee motivation and behavior in two ways. First, and perhaps most obviously, pay can affect the motivational intensity, direction, and persistence of current employees. Motivation, together with employee ability and work/organizational design (which can help or hinder employee performance), determines employee behaviors such as performance. We will refer to this effect of pay as an incentive effect, the degree to which pay influences individual and aggregate motivation among the employees we have at any point in time.
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EXHIBIT 1.4 Pay Rates at Retail Stores, Customer Satisfaction, Employee Turnover, and Sales/Square Ft.

Sources: Customer Satisfaction data from American Customer Satisfaction Index TM, http://www.theacsi.org/, retrieved April 4, 2021; Number of Stores, Revenues, Store Size, Number of Employees from Wal-Mart 10-K (Annual Report) and Costco 10-K (Annual Report). For Walmart, used only U.S. data; Average Wage from www.glassdoor.com, retrieved April 4, 2021. Note: There are wage and compensation data in Costco’s Annual Report (Form 10-K) and in Walmart’s Annual Report (Form 10-K) and more in Walmart’s Environmental, Social, and Governance Report. However, the data reported by Costco is total compensation, primarily for full-time U.S. employees, whereas Walmart includes many non-U.S. employees and reports wage or salary (rather than total compensation). Note: Revenue per sq. ft. equals Revenues/(Stores × Store Size Average)
a#4 on Forbes 2021 list. Top 50 in Glassdoor 2021 list.

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However, pay can also have an indirect, but important, influence via a sorting effect on the composition of the workforce.31 That is, different types of pay strategies may cause different types of people to apply to and stay with (i.e., self-select into) an organization. In the case of pay structure/level, it may be that higher pay levels help organizations attract more high-quality applicants, allowing them to be more selective in their hiring. Similarly, higher pay levels may improve employee retention. (In Chapter 7, we will talk about when paying more is most likely to be worth the higher costs.)
In other words, although perhaps less obvious, it is not only how much but how an organization pays that can result in sorting effects.32 Ask yourself: Would people who are highly capable and have a strong work ethic and an interest in earning a lot of money prefer to work in an organization that pays about the same amount to all employees doing the same job, regardless of their performance? Or would they prefer to work in an organization where their pay can be much higher (or lower) depending on how they perform? If you chose the latter answer, then you believe that sorting effects matter. People differ regarding which type of pay arrangement they prefer. The question for organizations is simply this: Are you using the pay policy that will attract and retain the types of employees you want? Keep in mind that high performers have more alternative job opportunities and that more opportunities, all else being equal (e.g., if they are not paid more for their higher performance), translate into higher turnover—which is likely to be a significant problem if it is the high performers who are leaving, especially if high performers in particular roles create a disproportionately high amount of value for organizations. This would be the case, for example, if performance, instead of following a normal distribution, follows a power law distribution, which allows more extreme values (e.g., in the form of very high and valuable performance).33
This also raises the issue of dealing with outside offers that employees receive. We know that a substantial share of employee turnover results from receiving unsolicited outside offers. In other words, turnover is not always in response to dissatisfaction. Sometimes it is driven by opportunity. These are likely to be some of the most valuable employees, and thus policies and practices for dealing with outside offers (hopefully informed by research) are important.34
Let’s take a look at one especially informative study conducted by Edward Lazear regarding incentive and sorting effects.35 Individual worker productivity was measured before and after a glass installation company switched one of its plants from a salary-only (no pay for performance) system to an individual incentive plan under which each employee’s pay depended on his/her own performance. An overall increase in plant productivity of 44 percent was observed comparing before and after. Roughly one-half of this increase was due to individual employees becoming more productive. However, the remaining one-half of the productivity gain was not explained by this fact. So, where did the other one-half of the gain come from? The answer: Less-productive workers were less likely to stay in their jobs under the new individual incentive system because it was less favorable to them. When they left, they tended to be replaced by more-productive workers (who were happy to have the chance to make more money under a system that rewards performance than they might make elsewhere). Thus, focusing only on the incentive effects of pay (on current workers) can miss the other major mechanism (sorting) by which pay decisions influence employee behaviors.
Some research looks at “stars.” For example, one study used data on individual security analysts in investment banks and found that newly hired “stars” from other firms generally did less well in their new firms, but their performance decline was less when moving with other members of their team, rather than alone.36 Thus, there are implications. First, star performance may be somewhat firm-specific. Second, a firm cannot necessarily “buy talent” and be sure that talent will perform at the same level as at its previous firm. Third, to the degree that is the case, the firm-specificity may stem at least partly from the additional value created by being part of a well-functioning team. Other research on stars, this time in the hedge fund industry, finds that, page 14compared to other members of their team, stars get more credit when things go well and more blame when things go poorly. Thus, working “in someone’s shadow” can be a plus when things don’t go well, but can lead to less credit when things go well.37
The pay model that comes later in this chapter includes compensation policies and the objectives (efficiency, fairness, compliance) these are meant to influence. Our point here is that compensation policies work through employee incentive and sorting effects to either achieve or not achieve those objectives.

Global Views—Vive la Différence
In English, compensation means something that counterbalances, offsets, or makes up for something else. However, if we look at the origin of the word in different languages, we get a sense of the richness of the meaning, which combines entitlement, return, and reward.38
In China, the traditional characters for the word “compensation” are based on the symbols for logs and water, suggesting that compensation provides the necessities in life. In the recent past the state owned all Chinese enterprises, and compensation was treated as an entitlement. In today’s China, compensation takes on a more subtle meaning. A new word, dai yu, is used. It refers to how you are being treated—your wages, benefits, training opportunities, and so on. When people talk about compensation, they ask each other about the dai yu in their companies. Rather than assuming that everyone is entitled to the same treatment, the meaning of compensation now includes a broader sense of returns as well as entitlement.39
“Compensation” in Japanese is kyuyo, which is made up of two separate characters (kyu and yo), both meaning “giving something.” Kyu is an honorific used to indicate that the person doing the giving is someone of high rank, such as a feudal lord, an emperor, or a samurai leader. Traditionally, compensation is thought of as something given by one’s superior. Today, business consultants in Japan try to substitute the word housyu, which means “reward” and has no associations with notions of superiors. The many allowances that are part of Japanese compensation systems translate as teate, which means “taking care of something.” Teate is regarded as compensation that takes care of employees’ financial needs. This concept is consistent with the family, housing, and commuting allowances that are still used in many Japanese companies.40
These contrasting ideas about compensation—multiple views (societal, stockholder, managerial, employee, and even global) and multiple meanings (returns, rewards, entitlement)—add richness to the topic. But they can also cause confusion unless everyone is talking about the same thing. So let’s define what we mean by “compensation” or “pay” (the words are used interchangeably in this book):

Compensation refers to all forms of financial returns and tangible services and benefits employees receive as part of an employment relationship.

FORMS OF PAY
Exhibit 1.5 shows the variety of returns people receive from work. Total returns are categorized as total compensation and relational returns. The relational returns (learning opportunities, status, challenging work, and so on) are psychological.41 Total compensation returns are more transactional. They include pay received directly as cash (e.g., base, merit, incentives, cost-of-living adjustments) and indirectly as benefits (e.g., pensions, medical insurance, programs to help balance work and life demands, brightly colored uniforms).42 So page 15pay comes in different forms, and programs to pay people can be designed in a wide variety of ways. Worldat-Work has a Total Rewards Model that is similar and includes compensation, benefits, work-life, performance/recognition, and development/career opportunities.43 The importance of monetary rewards as a motivator relative to other rewards (e.g., intrinsic rewards such as how interesting the work is) has long been a topic of interest, as have the conditions under which money is more or less important to people (and even whether money is sometimes too important to people).44 Although scholars and pundits have sometimes debated which is more important (and have sometimes argued that money does not motivate or even that it demotivates), our reading of the research indicates that both types of rewards are important and that it is usually not terribly productive to debate which is more important.45 It will no doubt come as little surprise that we will focus on monetary rewards (total compensation) in a book called Compensation. Whatever other rewards employees value, it is our experience that they expect to be paid for their work, that how and how much they are paid affects their attitudes, performance, and job choice, as well as their standard of living. These effects of compensation on employees (as well as the cost of employee compensation) have major implications for how successfully organizations can execute their strategies and achieve their goals, as we will see.

EXHIBIT 1.5 Total Returns for Work

Cash Compensation: Base
Base wage is the cash compensation that an employer pays for the work performed. Base wage tends to reflect the value of the work or skills and generally ignores differences attributable to individual employees. For example, the base wage for machine operators may be $20 an hour. However, some individual operators may receive more because of their experience and/or performance. Some pay systems set base wage as a function of the skill or education an employee possesses; this is common for engineers and schoolteachers.46
A distinction is often made in the United States between wage and salary, with salary referring to pay for employees who are exempt from regulations of the Fair Labor Standards Act (FLSA) and hence do not receive overtime pay.47 Managers and professionals usually fit this category. Their pay is calculated at an annual or monthly rate rather than hourly, because hours worked do not need to be recorded. In contrast, workers who are covered by overtime and reporting provisions of the Fair Labor Standards Act—nonexempts—have their pay calculated as an hourly wage. Some organizations, such as IBM, Eaton, and Walmart, label all base pay as “salary.” Rather than dividing employees into separate categories of salaried and wage earners, they believe that an “all-salaried” workforce reinforces an organizational culture in which all employees are part of the same team. However, merely changing the terminology does not negate the need to comply with the FLSA.

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Cash Compensation: Merit Increases/Short-Term Incentives (Merit Bonuses)/COLAs
A cost of living adjustment (COLA) to base wages may be made on the basis of changes in what other employers are paying for the same work, changes in living costs, or changes in experience or skill. Such provisions are less common than in the past as employers continually try to control fixed costs and link pay increases to individual and/or company performance.
Merit increases are given as increments to base pay and are based on performance.48 According to a WorldatWork survey, 94 percent of U.S. firms use merit pay increases.49 Given that 22 percent of respondents to the survey were in the nonprofit, not-for-profit, or public sectors where we know that the use of merit pay is less,50 it may be that nearly 100 percent of U.S. private sector organizations use merit pay. Merit payments are based on an assessment (or rating) of recent past performance made (with or without a formal performance evaluation). In recent years, merit increase budgets (or average merit increases) have been around 3 percent.51 Survey data indicate that, on average, an outstanding performer receives a 4.8 percent increase, an average performer a 2.9 percent increase, and a poor performer a 0.2 percent increase.52 Finally, companies increasingly use merit bonuses.53 As with merit increases, merit bonuses are based on a performance rating but, unlike merit increases, are paid in the form of a lump sum rather than becoming (a permanent) part of the base salary.54 Merit bonuses (also referred to as short-term incentives) may now be more important than traditional merit increases. “Indeed, merit bonuses now appear to account for more of the pay-performance relationship than do the traditional and most often discussed form of pay for individual performance, merit pay.”55 In companies that use merit bonuses and among those workers who receive them, the average annual merit bonus in recent years has been about 6 percent for hourly employees, 7 percent for lower level salaried employees, and 11 percent for higher level (but below officers/executives) salaried employees, all much larger than the more often discussed recent merit increase pools of around 3 percent.56 We return to this issue in Chapter 18.

Cash Compensation: Incentives
Incentives also tie pay increases to performance.57 However, incentives differ from merit adjustments. First, incentives are tied to objective performance measures (e.g., sales) usually in a formula-based way, whereas a merit increase program typically relies on a subjective performance rating. There is also some subjectivity in the size of the pay increase awarded for a particular rating. Second, incentives do not increase the base wage and so must be re-earned each pay period. Third, the potential size of the incentive payment will generally be known (given the use of a formula) beforehand. Whereas merit pay programs evaluate past performance of an individual and then decide on the size of the increase, what must happen in order to receive the incentive payment is called out very specifically ahead of time. For example, a Toyota salesperson knows the commission on a Land Cruiser versus a Prius prior to making the sale. The larger commission he or she will earn by selling the Land Cruiser is the incentive to sell a customer that car rather than the Prius. Fourth, while both merit pay and incentives try to influence performance, incentives explicitly try to influence future behavior whereas merit recognizes (rewards) past behavior, which is hoped to influence future behavior. The incentive-reward distinction is a matter of timing.
Incentives can be tied to the performance of an individual employee, a team of employees, a total business unit, or some combination of individual, team, and unit.58 The performance objective may be expense reduction, volume increases, customer satisfaction, revenue growth, return on investments, increase in stock value—the possibilities are endless. Prax Air, for example, used return on capital (ROC). For every quarter in page 17which a 6 percent ROC target is met or exceeded, Prax Air awarded bonus days of pay. An 8.6 percent ROC means two extra days of pay for that quarter for every employee covered by the program. An ROC of 15 percent means 8.5 extra days of pay.
Because incentives are one-time payments, they do not permanently increase labor costs. When performance declines, incentive pay automatically declines, too. Consequently, incentives (and sometimes merit bonuses also) are frequently referred to as variable pay.
Incentives can have powerful effects, both good and bad, on performance. On average, these effects are positive and substantial.59 However, incentives are risky, and they can go wrong in spectacular fashion.60 One example is the Great Financial Crisis, which apparently stemmed in large part from improper and aggressive incentives paid to encourage loan officers to give home loans (mortgages) to people who were unlikely to be able to pay them back. (Recent events at Wells Fargo provide further examples.) We will talk about more examples in later chapters.

Long-Term Incentives
Incentives may be short-or long-term. Long-term incentives are intended to focus employee efforts on multiyear results. Typically they are in the form of stock ownership or else options to buy stock at a fixed price (thus leading to a monetary gain to the degree the stock price later goes up). The belief underlying stock ownership is that employees with a financial stake in the organization will focus on long-term financial objectives: return on investment, market share, return on net assets, and the like. Bristol-Myers Squibb grants stock to selected “Key Contributors” who make outstanding contributions to the firm’s success. Stock options are often the largest component in an executive pay package. Some companies extend stock ownership beyond the ranks of executives and/or other high salary employees. Examples of companies that provide both broad-based equity awards and employee stock purchase plans include Cisco, Intuit, Adobe Systems, and Goldman Sachs.61

Benefits: Income Protection
Exhibit 1.5 showed that benefits, including income protection, work/life services, and allowances, are also part of total compensation. Indeed, benefits add an average of $0.46 in cost for every $1.00 in wages and salaries. (See Chapter 12.) Some income protection programs are legally required in the United States; employers must pay into a fund that provides income replacement for workers who become disabled or unemployed. Employers are also required to pay one-half the payroll tax for each employee to fund Social Security coverage. (Employees pay the other half.) Different countries have different lists of mandatory benefits.
Medical insurance, retirement programs, life insurance, and savings plans are common benefits. They help protect employees from the financial risks inherent in daily life. Often companies can provide these protections to employees more cheaply than employees can obtain them for themselves. In the United States, employers spend roughly $725 billion per year just on health care costs, or 19 percent of all U.S. health care expenditures.62 Among employers that provide health insurance, the cost to provide family coverage is $21,342 per year per employee. The average employer pays $15,574 (74 percent) of that and the average employee pays the remaining $5,588 (26 percent).63 Given the magnitude of such costs, it is no surprise that employers have sought to rein in or reduce benefits costs. One approach has been to shift costs to employees (e.g., having employees pay a larger share of health insurance premiums).64 Some companies have allowed their benefits costs to get so far out of control that more drastic action has been taken. For example, as noted, page 18companies like Chrysler, GM, and American Airlines have recently gone through bankruptcy, which has been used to reduce benefits costs and labor costs more generally. GM benefits costs had gotten so high that GM was sometimes described as a pension and health care provider that also makes cars.

Benefits: Work/Life Balance
Programs that help employees better integrate their work and life responsibilities include time away from work (vacations, jury duty), access to services to meet specific needs (drug counseling, financial planning, referrals for child and elder care), and flexible work arrangements (e.g., remote work, nontraditional schedules, nonpaid time off). Responding to the changing demographics of the workforce (two-income families or single parents who need work-schedule flexibility to meet their family obligations), many U.S. employers are giving a higher priority to these benefit forms. (This trend was reinforced by the pandemic.) Medtronic, for example, touts its Total Well-Being Program that seeks to provide “resources for growth—mind, body, heart, and spirit” for each employee. Health and wellness, financial rewards and security, individual and family well-being, and a fulfilling work environment are part of this “total well-being.”65 Medtronic believes that this program permits employees to be “fully present” at work and less distracted by conflicts between their work and nonwork responsibilities.

Benefits: Allowances
Allowances often grow out of whatever is in short supply. In Vietnam and China, housing (dormitories and apartments) and transportation allowances are frequently part of the pay package. Many decades after the end of World War II-induced food shortages, some Japanese companies still continue to offer a “rice allowance” based on the number of an employee’s dependents. Almost all foreign companies in China discover that housing, transportation, and other allowances are expected.66 Companies that resist these allowances must come up with other ways to attract and retain employees. In many European countries, managers assume that a car will be provided—only the make and model are negotiable.67

Total Earnings Opportunities: Present Value of a Stream of Earnings
Up to this point we have treated compensation as something received at a moment in time. But a firm’s compensation decisions have a temporal effect. Say you have a job offer at $50,000 a year. If you stay with the firm for five years and receive an annual increase of 4 percent, in five years you will be earning $60,833 a year. For your employer, the five-year cost commitment of the decision to hire you turns out to be $331,649 in cash. If you add in an additional 30 percent for benefits, the decision to hire you implies a commitment of over $430,000 from your employer. Will you be worth it? You will be, after this course.
A present-value perspective shifts the comparison of today’s initial offers to consideration of future bonuses, merit increases, and promotions. Sometimes a company will tell applicants that its relatively low starting offers will be overcome by larger future pay increases. In effect, the company is selling the present value of the future stream of earnings. But few candidates apply that same analysis to calculate the future increases required to offset the lower initial offers. Hopefully, everyone who reads Chapter 1 will now do so.

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Relational Returns from Work
Why do Google millionaires continue to show up for work every morning? Why does Andy Borowitz write the funniest satirical news site on the web (www.borowitzreport.com) for free? There is no doubt that nonfinancial returns from work have a substantial effect on employees’ behavior.68 Exhibit 1.5 includes such relational returns from work as recognition and status, employment security, challenging work, and opportunities to learn. Other forms of relational return might include personal satisfaction from successfully facing new challenges, teaming with great co-workers, receiving new uniforms, and the like.69 Such factors are part of the total return, which is a broader umbrella than total compensation. Interestingly, as you may have noticed, the types of rewards just listed, other than money, are sometimes viewed as being, for lack of a better word, more noble (or higher order as Maslow and Herzberg might say) than money. In fact, at least one study reports that candidates for a job who come across as more motivated by money are sometimes inferred to have lower levels of higher order motivations, resulting in them being evaluated lower. The researchers refer to this as “motivation purity bias.”70 So, as always, think about how you want to present yourself (including in terms of your motivation purity) and come across when you interview!

The Organization as a Network of Returns
Sometimes it is useful to think of an organization as a network of returns created by all these different forms of pay, including total compensation and relational returns. The challenge is to design this network so that it helps the organization to succeed.71 As in the case of crew rowers pulling on their oars, success is more likely if all are pulling in unison rather than working against one another. In the same way, the network of returns is more likely to be useful if bonuses, development opportunities, and promotions all work together.
So the next time you walk through an employer’s door, look beyond the cash and health care offered to search for all the returns that create the network. Even though this book focuses on compensation, let’s not forget that compensation is only one of many factors affecting people’s decisions about work. (You might enjoy listening to Roger Miller’s song “Kansas City Star,” or Chely Wright’s “It’s the Song” for some other reasons people choose their work.)

A PAY MODEL
The pay model shown in Exhibit 1.6 serves as both a framework for examining current pay systems and a guide for most of this book. It contains three basic building blocks: (1) the compensation objectives, (2) the policies that form the foundation of the compensation system, and (3) the techniques that make up the compensation system. Because objectives drive the system, we will discuss them first.

EXHIBIT 1.6 The Pay Model

Compensation Objectives
Pay systems are designed to achieve certain objectives. The basic objectives, shown at the right side of the model, include efficiency, fairness, ethics, and compliance with laws and regulations. Efficiency can be stated more specifically: (1) improving performance, increasing quality, delighting customers and stockholders, and (2) controlling labor costs.
Compensation objectives at Medtronic and Whole Foods are contrasted in Exhibit 1.7. Medtronic is a medical technology company that pioneered cardiac pacemakers. Its compensation objectives emphasize performance, business success, minimizing fixed costs, and attracting and energizing top talent.
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EXHIBIT 1.7 Pay Objectives at Medtronic and Whole Foods

Medtronic
Whole Foods

Support Medtronic mission and increased complexity of business
Increase long-term shareholder value

Minimize increases in fixed costs
Earn profits daily through voluntary exchange with our customers

Attract and engage top talent
Through profits, create capital for growth, prosperity, opportunity, job satisfaction, and job security

Emphasize personal, team, and Medtronic performance
Support team member happiness and excellence

Recognize personal and family total well being
Acknowledge that team outcomes are collective

Ensure Fair Treatment: and Acknowledge that team outcomes are collective should be on their own line.
 

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Whole Foods is the nation’s largest organic-and natural-foods grocer. Its markets are a “celebration of food”: bright, well stocked, and well staffed.72 The company describes its commitment to offering the highest quality and least processed foods as a shared responsibility. Its first compensation objective is “Increase long-term shareholder value.”
Fairness (sometimes called equity) is a fundamental objective of pay systems.73 In Medtronic’s objectives, fairness means to “ensure fair treatment” and “recognize personal and family well-being.” Whole Foods’s pay objectives discuss a “shared fate.” In their egalitarian work culture, pay beyond base wages is linked to team performance, and employees have some say about who is on their team.
The fairness objective calls for fair treatment for all employees by recognizing both employee contributions (e.g., higher pay for greater performance, experience, or training) and employee needs (e.g., a fair wage as well as fair procedures). Procedural fairness refers to the process used to make pay decisions.74 It suggests that the way a pay decision is made may be equally as important to employees as the results of the decision (distributive fairness).
Compliance as a pay objective means conforming to federal and state compensation laws and regulations. If laws change, pay systems may need to change, too, to ensure continued compliance. As companies go global, they must comply with the laws of all the countries in which they operate.

Ethics
Asian philosophy gives us the concept of yin and yang—complementary opposites rather than substitutes or trade-offs. It is not yin or yang; part of yin is in yang, and part of yang is in yin. So it is with objectives in the pay model. It is not efficiency versus fairness versus compliance. Rather, the aim is to achieve all three simultaneously. The tension of working toward all objectives at once creates fertile grounds for ethical dilemmas.
Ethics means the organization cares about how its results are achieved.75 Scan the websites or lobby walls of corporate headquarters and you will inevitably find statements of “Key Behaviors,” “Our Values,” and “Codes of Conduct.” One company’s code of conduct is shown in Exhibit 1.8. The challenge is to put these statements into daily practice. The company in the exhibit is the formerly admired, now reviled, Enron, whose employees lost not only their Enron jobs, but also the money they invested in Enron stock (in some cases, their entire retirement nest egg).
EXHIBIT 1.8 Enron’s Ethics Statement

Foreword

“As officers and employees of Enron Corp., its subsidiaries, and its affiliated companies, we are responsible for conducting the business affairs of the companies in accordance with all applicable laws and in a moral and honest manner.… We want to be proud of Enron and to know that it enjoys a reputation for fairness and honesty and that it is respected.… Enron’s reputation finally depends on its people, on you and me. Let’s keep that reputation high.”

July 1, 2000

Kenneth L. Lay

Chairman and Chief Executive Officer

Values

Respect
We treat others as we would like to be treated ourselves. We do not tolerate abusive or disrespectful treatment. Ruthlessness, callousness, and arrogance don’t belong here.

Integrity
We work with customers and prospects openly, honestly, and sincerely. When we say we will do something, we will do it; when we say we cannot or will not do something, then we won’t do it.

Communication
We have an obligation to communicate. Here, we take the time to talk with one another … and to listen.

Excellence
We are satisfied with nothing less than the very best in everything we do.… The great fun here will be for all of us to discover just how good we can really be.

Source: Enron’s Code of Ethics, The Smoking Gun, July 2000.
Because it is so important, it is inevitable that managing pay sometimes creates ethical dilemmas. Manipulating results to ensure executive bonus payouts, misusing (or failing to understand) statistics used to measure competitors’ pay rates, repricing or backdating stock options to manipulate (increase) their value, encouraging employees to invest a portion of their wages in company stock while executives are bailing out, offering just enough pay to get a new hire in the door while ignoring the relationship to co-workers’ pay, and shaving the hours recorded in employees’ time card—these are all-too-common examples of ethical lapses.
Some, but not all, compensation professionals and consultants remain silent during ethical misconduct and outright malfeasance. Absent a professional code, compensation managers must look to their own ethics—and the pay model, which calls for combining the objectives of efficiency and fair treatment of employees as well as compliance.76
There are probably as many statements of pay objectives as there are employers. In fact, highly diversified firms such as General Electric and Eaton, which operate in multiple lines of businesses, may have different pay objectives for different business units. At General Electric, each unit’s objectives must meet GE overall objectives.
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Objectives serve several purposes. First, they guide the design of the pay system. If an objective is to increase customer satisfaction, then incentive programs and merit pay might be used to pay for performance. Another employer’s objective may be to develop innovative new products. Job design, training, and team building may be used to reach this objective. The pay system aligned with this objective may include salaries that are at least equal to those of competitors (external competitiveness) and that go up with increased skills or knowledge (internal alignment). This pay system could be very different from our first example, where the focus is on increasing customer satisfaction. Notice that policies and techniques are the means to reach the objectives.
In summary, objectives guide the design of pay systems. They also serve as the standards for judging the success of the pay system. If the objective is to attract and retain the best and the brightest skilled employees, but they are leaving for higher-paying jobs elsewhere, the system may not be performing effectively. Although there may be many nonpay reasons for such turnover, objectives provide standards for evaluating the effectiveness of a pay system.77

Four Policy Choices
Every employer must address the policy decisions shown on the left side of the pay model: (1) internal alignment, (2) external competitiveness, (3) employee contributions, and (4) management of the pay system. These policies are the foundation on which pay systems are built. They also serve as guidelines for managing pay in ways that accomplish the system’s objectives.

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Internal Alignment
Internal alignment refers to comparisons among jobs or skill levels inside a single organization. Jobs and people’s skills are compared in terms of their relative contributions to the organization’s business objectives. How, for example, does the work of the programmer compare with the work of the systems analyst, the software engineer, and the software architect? Does one contribute to solutions for customers and satisfied stockholders more than another? What about two marketing managers working in different business units of the same organization? Internal alignment pertains to the pay rates both for employees doing equal work and for those doing dissimilar work. In fact, determining what is an appropriate difference in pay for people performing different work is one of the key challenges facing managers. Whole Foods tries to manage differences with a salary cap that limits the total cash compensation (wages plus bonuses) of any executive to 19 times the average cash compensation of all full-time employees. The cap originally started at eight times the average. However, attraction and retention problems were cited as a need for raising the cap several times since. (Note that the cap does not include stock options.)
Pay relationships within the organization affect all three compensation objectives. They affect employee decisions to stay with the organization, to become more flexible by investing in additional training, or to seek greater responsibility. By motivating employees to choose increased training and greater responsibility in dealing with customers, internal pay relationships indirectly affect the capabilities of the workforce and hence the efficiency of the entire organization. Fairness is affected through employees’ comparisons of their pay to the pay of others in the organization. Compliance is affected by the basis used to make internal comparisons. Paying on the basis of race, gender, age, or national origin is illegal in the United States.

External Competitiveness
External competitiveness refers to pay comparisons with competitors. How much do we wish to pay in comparison to what other employers pay?
Many organizations claim their pay systems are market-driven—that is, based almost exclusively on what competitors pay. “Market-driven” gets translated into practice in different ways.78 Some employers may set their pay levels higher than their competition, hoping to attract the best applicants. Of course, this assumes that someone is able to identify and hire the “best” from the pool of applicants. And what is the appropriate market? When, for example, should international pay rates be considered? Should the pay of software engineers in New Delhi or Minsk influence pay for engineers in Silicon Valley or Boston?
External competitiveness decisions—both how much and what forms—have a twofold effect on objectives: (1) to ensure that the pay is sufficient to attract and retain employees—if employees do not perceive their pay as competitive in comparison to what other organizations are offering for similar work, they may be more likely to leave—and (2) to control labor costs so that the organization’s prices of products or services can remain competitive in a global economy.

Employee Contributions
How much emphasis should there be on paying for performance? Should one programmer be paid differently from another if one has better performance and/or greater seniority? Or should there be a flat rate for programmers? Should the company share any profits with employees? Should it share with all employees, parttime as well as full-time?
The emphasis to place on employee contributions (or nature of pay mix) is an important policy decision because it directly affects employees’ attitudes and work behaviors. Eaton and Motorola use pay to support other “high-performance” practices in their workplaces.79 Both use team-based pay and corporate profit-sharing plans. page 24Starbucks emphasizes stock options and sharing the success of corporate performance with the employees. General Electric uses different performance-based pay programs at the individual, division, and company-wide levels. Performance-based pay affects fairness, in that employees need to understand the basis for judging performance in order to believe that their pay is fair.
What mix of pay forms—base, incentives, stock, benefits—do our competitors use in comparison to the pay mix we use? Whole Foods combines base pay and team incentives to offer higher pay if warranted by team performance. Nucor targets base pay below market, but targets total cash compensation (including profit sharing and gain-sharing/plant production bonuses) at well above the market median. Medtronic sets its base pay to match its competitors but ties bonuses to performance. It offers stock to all its employees, based on overall company performance.80 Further, Medtronic believes that its benefits, particularly its emphasis on programs that balance work and life, make it a highly attractive place to work. It believes that how its pay is positioned and what forms it uses create an advantage over competitors.
The external competitiveness and employee contribution decisions should be made jointly. Clearly, an above-market compensation level is most effective and sustainable when it exists together with above-market employee contributions to productivity, quality, customer service, or other important strategic objectives.

Management
A policy regarding management of the pay system is the last building block in our model. Management means ensuring that the right people get the right pay for achieving the right objectives in the right way. The greatest system design in the world is useless without competent management.
Managing compensation means answering the “So What?” question. So what is the impact of this policy, this technique, this decision? Although it is possible to design a system that is based on internal alignment, external competitiveness, and employee contributions, what difference does it make? Does the decision help the organization achieve its objectives?81
The ground under compensation management has shifted. The traditional focus on how to administer various techniques is long gone, replaced by more strategic thinking—managing pay as part of the business. It goes beyond simply managing pay as an expense to better understanding and analyzing the impact of pay decisions on people’s behaviors and organizations’ success. The impact of pay decisions on expenses is one result that is easily measured and well understood. But other measures—such as pay’s impact on attracting and retaining the right people, and engaging these people productively—are not yet widely used in the management of compensation. Efforts to do so are increasing, and the perspective is shifting from “How to” toward trying to answer the “So What?” question.82 Ease of measurement is not the same as importance; costs are easy to measure (and, of course, important), so there is a tendency to focus there. Yet the consequences of pay, although often less amenable to measurement, are nonetheless just as important.

Pay Techniques
The remaining portion of the pay model in Exhibit 1.6 shows the techniques that make up the pay system. The exhibit provides only an overview since techniques are discussed throughout the rest of the book. Techniques tie the four basic policies to the pay objectives.
Uncounted variations in pay techniques exist; many are examined in this book. Most consultant firms tout their surveys and techniques on their web pages. You can obtain updated information on various practices by simply surfing the web.
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e-Compensation
WorldatWork (www.worldatwork.org) provides information on its compensation-related journals and special publications, as well as short courses aimed at practitioners. The Society of Human Resource Management (www.shrm.org) also offers compensation-related information as well as more general human resource management (HRM) information. The society’s student services section offers guidance on finding jobs in the field of human resources. Both sites are good sources of information for people interested in careers in HRM. Information on pay trends in Europe is available from the European Industrial Relations Observatory (http://www.eurofound.europa.eu/observatories/eurwork). The International Labour Organization (www.ilo.org) maintains a database that can be browsed either by subject (conditions of employment) or country. Cornell University’s Industrial and Labor Relations School offers a “research portal” for articles of interest in human resource management (http://guides.library.cornell.edu/hrm). The Employee Benefits Research Institute (EBRI) includes links to other benefits sources on its website (www.ebri.org). Every chapter in this book also mentions interesting websites. Use them as a starting point to search out others.

BOOK PLAN
Compensation is such a broad and compelling topic that there are several books devoted to it. This book focuses on the design and management of compensation systems. To aid in understanding how and why pay systems work, our pay model provides the structure for much of the book. Chapter 2 discusses how to formulate and execute a compensation strategy. We analyze what it means to be strategic about how people are paid and how compensation can help achieve and sustain an organization’s competitive advantage.83
The pay model plays a central role in formulating and implementing an organization’s pay strategy. The model identifies four basic policy choices that are the core of the pay strategy. After we discuss strategy, the next sections of the book examine each of these policies in detail. Part 2 on internal alignment (Chapters 3, 4, 5, and 6) examines pay relationships within a single organization. Part 3 (Chapters 7 and 8) examines external competitiveness—the pay relationships among competing organizations—and analyzes the influence of market-driven forces.
Once the compensation rates and structures are established, other issues emerge. How much should we pay each individual employee? How much and how often should a person’s pay be increased, and on what basis—experience, seniority, or performance? Should pay increases be contingent on the organization’s and/or the employee’s performance? How should the organization share its success (or failure) with employees? These are questions of employee contributions, the third building block in the model, covered in Part 4 (Chapters 9, 10, and 11).
In Part 5, we cover employee services and benefits (Chapters 12 and 13). How do benefits fit in the company’s overall compensation package? What choices should employees have in their benefits? In Part 6, we cover systems tailored for special groups—sales representatives, executives, contract workers, unions (Chapters 14 and 15)—and we provide more detail on global compensation systems (Chapter 16). Part 7 concludes with information essential for managing the compensation system. The government’s role in compensation is examined in Chapter 17. Chapter 18 includes understanding, communicating, budgeting, and evaluating results.
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Even though the book is divided into sections that reflect the pay model, pay decisions are not discrete. All of them are interrelated. Together, they influence employee behaviors and organization performance and can create a pay system that can be a source of competitive advantage.
Throughout this book our intention is to examine alternative approaches. We believe that there rarely is a single correct approach; rather, alternative approaches exist or can be designed. The one most likely to be effective depends on the circumstances. We hope that this book will help you become better informed about these options, how to evaluate and select the most effective ones, and how to design new ones. Whether as an employee, a manager, or an interested member of society, you should be able to assess the effectiveness and fairness of pay systems.

CAVEAT EMPTOR—BE AN INFORMED CONSUMER
Most managers do not read research. They do not subscribe to research journals; they find them too full of jargon and esoterica, and they see them as impractical and irrelevant.84 However, a study of 5,000 HR managers compared their beliefs to the research evidence in several areas and identified seven common and important misconceptions held by managers.85 The study authors concluded that being unaware of key research findings may prove costly to organizations. For example, when it comes to motivating workers, organization efforts may be somewhat misguided if they do not know that “money is the crucial incentive … no other incentive or motivational technique comes even close to money with respect to its instrumental value.”86
So it pays to read the research. There is no question that some studies are irrelevant and poorly performed. But if you are not a reader of research literature, you become prey for the latest business self-help fad. Belief, even enthusiasm, is a poor substitute for informed judgment. Therefore, we end this chapter with a consumer’s guide to research that includes three questions to help make you a critical reader—and a better-informed decision maker.

1. Is the Research Useful?
How useful are the variables in the study? How well are they measured? For example, many studies purport to measure organization performance. However, performance may be accounting measures such as return on assets or cash flow, financial measures such as earnings per share, operational measures such as scrap rates or defect indicators, or qualitative measures such as customer satisfaction. It may even be the opinions of compensation managers, as in, “How effective is your gain-sharing plan?” (Answer choices are “highly effective,” “effective,” “somewhat,” “disappointing,” “not very effective.” “Disastrous” is not usually one of the choices.) The informed consumer must ask, Does this research measure anything useful?

2. Does the Study Separate Correlation from Causation?
Once we are confident that the variables are useful and accurately measured, we must be sure that they are actually related. Most often this is addressed through the use of statistical analysis. The correlation coefficient is a common measure of association and indicates how changes in one variable are related to changes in another. Many research studies use a statistical analysis known as regression analysis. One output from a regression analysis is the R2. The R2 is a squared correlation and tells us what percentage of the variation in the outcome variable is accounted for by the variables we are using to predict or explain.
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But even if there is a relationship, correlation does not ensure causation. For example, just because a manufacturing plant initiates a new incentive plan and the facility’s performance improves, we cannot conclude that the incentive plan caused the improved performance. Perhaps new technology, reengineering, improved marketing, or the general expansion of the local economy underlies the results. The two changes are associated or related, but causation is a tough link to make.
Too often, case studies, benchmarking studies of best practices, or consultant surveys are presented as studies that reveal cause and effect. They do not. Case studies are descriptive accounts whose value and limitations must be recognized. Just because the best-performing companies are using a practice does not mean the practice is causing the performance. IBM provides an example of the difficulty of deciding whether a change is a cause or an effect. Years ago, IBM pursued a no-layoff policy. While IBM was doing well, the no-layoff policy was cited as part of the reason. Later, when performance declined, IBM eventually ended the no-layoff policy as a partial response. Did the policy contribute to company success at one time, but not later due to changing circumstances? Did it always act as a drag on company success? Or was it a mistake to get rid of it? Causality is difficult to infer as we do not know what would have happened had IBM never had the policy and/or if they had it and kept it (versus ending it). Perhaps because of such challenges in inference, compensation research often does attempt to answer questions of causality. Yet good policy decisions rest on making good causal inferences.87 Thus, we need to strive to overcome the challenges to answer key questions such as: How does the use of performance-based pay influence employee ability and motivation, customer satisfaction, product quality, and company performance?

3. Are There Alternative Explanations?
Consider a hypothetical study that attempts to assess the impact of a performance-based pay program. The researchers measure performance by assessing quality, productivity, customer satisfaction, employee satisfaction, and the facility’s performance. The final step is to see whether future periods’ performance improves compared to this period’s. If it does, can we safely assume that it was the incentive pay that caused performance? Or is it equally likely that the improved performance has alternative explanations, such as the fluctuation in the value of currency, changes in competition, or perhaps a change in leadership or other human resource practices in the facility?
In this case, causality evidence seems weak. Alternative explanations exist. If the researchers had measured the performance indicators several years prior to and after installing the plan, then the evidence of causality is perhaps a bit stronger. The evidence would be stronger if an equivalent group (a control group) had no pay program change and experienced no increase in performance. Further, if the researchers repeated this experiment in other facilities and the results were similar, then the preponderance of evidence is stronger yet. It could then be concluded that clearly the organization is doing something right, and incentive pay is part of it.
The best way to establish causation is to account for competing explanations, either statistically or through control groups. The point is that alternative explanations often exist. And if they do, they need to be accounted for to establish causality. It is very difficult to disentangle the effects of pay plans to clearly establish causality. However, it is possible to look at the overall pattern of evidence to make judgments about the effects of pay.
So we encourage you to become a critical reader of all management literature, including this book. As Hogwarts’ famous Professor Alastor Moody cautions, have “constant vigilance for sloppy analysis masquerading as research.”88
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Your Turn Compensation at the World’s Largest Company

Walmart is the largest company in the world in terms of revenue and employees. It is also a company that gets talked about a lot. Take this opportunity to do a bit of research on how compensation works there. Do a search for Walmart’s Environmental, Social & Governance Report. It should be readily available. (You can also check whether the following links are still active: https://corporate.walmart.com/esgreport2019/ and https://corporate.walmart.com/esgreport/.) Download the most recent report and, if available, download the two most recent full reports. Go to the Social section of both reports and examine the information related to pay (including benefits), promotion, and opportunity for Walmart employees.
QUESTIONS:

What is the minimum pay at Walmart? What is the average pay at Walmart? To what degree has each changed year to year?
Promotion to higher job levels is the main way that pay increases over the course of one’s career. What are the promotion opportunities like at Walmart? How much is opportunity is there for career and pay growth?
To what degree has Walmart achieved desirable levels of diversity and inclusion? What steps is the company taking to improve in this area?
How does Walmart describe its approach to safeguarding the treatment of workers (including fair pay) in its supply chain?
We know that Walmart keeps a careful eye on compensation cost of its employees, as part of its strategy of keeping its product prices low. What about workers it does not employ, but that are in its supply chain? Of what relevance is Walmart’s supply chain (and the workers in it) to Walmart keeping its prices low?
Walmart recently announced a commitment to sourcing $10 billion in India-made goods by 2027. (https://corporate.walmart.com/newsroom/2020/12/10/walmart-commits-to-sourcing-10-billion-of-india-made-goods-each-year-by-2027). Search the web for data on wage levels (minimum wage or actual wages) in India. How do wages in India compare to those in the United States? How will sourcing more goods from India help Walmart with its low price strategy? Where else does Walmart source from and how do wages in those countries compare to those in the United States?

Still Your Turn Who Are Amazon’s Peer Companies for Comparing Compensation?

A Wall Street Journal article on April 4, 2021, “Amazon’s Labor Unrest May Show at the Margins,” described Amazon as having “thin margins by tech standards,” noting that Amazon’s revenue/employee was only about one-fifth as large as “peers” such as Alphabet (Google), Apple, Facebook, and Microsoft. The Journal seemed to be suggesting that if unionization is successful at Amazon (on a significant scale, i.e., beyond the one current location where a union organizing drive is taking place), that Amazon’s labor costs will increase and it cannot afford that if its margins are already thin. Why would the Journal use these tech companies as peers? Isn’t Walmart a better peer comparison?
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To get better insight, go to the most recent annual reports (form 10-k), readily available on the web, and compute revenue per employee for Walmart and Amazon. (At Amazon, use net sales as revenue.) Also, compute the ratio of operating income to revenue by business segment for Walmart and Amazon. (Revenue per employee is not possible to compute based on the Amazon annual report.) Each company has three business segments.
QUESTIONS:

How do the revenue/employee numbers compare across companies?
How does the ratio of operating income to revenue compare across segments within and across the companies? Focusing on Amazon, how do these operating income/revenue ratios differ across its segments?
We will see that choosing peer companies to compare compensation includes those that are product market competitors, as well as labor market competitors. Based on the ratios you have computed and examined, who are Amazon’s product market competitors?

Summary
The model presented in this chapter provides a structure for understanding compensation systems. The three main components of the model are the compensation objectives, the policy decisions that guide how the objectives are going to be achieved, and the techniques that make up the pay system and link the policies to the objectives. The following sections of the book examine each of the four policy decisions—internal alignment, external competitiveness, employee performance, and management—as well as the techniques, new directions, and related research.
Two questions should constantly be in the minds of managers and readers of this text. First, Why do it this way? There is rarely one correct way to design a system or pay an individual. Organizations, people, and circumstances are too varied. But a well-trained manager can select or design a suitable approach. Second, So what? What does this technique do for us? How does it help achieve our goals? If good answers to the “So What?” question are not apparent, there is no point to the technique. Adapting the pay system to meet the needs of the employees and helping to achieve the goals of the organization is what this book is all about.
The basic premise of this book is that compensation systems do have a profound impact. Yet, too often traditional pay systems seem to have been designed in response to some historical but long-forgotten problem. The practices continue, but the logic underlying them is not always clear or even relevant. Hopefully, the next generation of pay systems will be more flexible—designed to achieve specific objectives under changing conditions.
Review Questions

How do differing perspectives affect our views of compensation?
What is your definition of compensation? Which meaning of compensation seems most appropriate from an employee’s view: return, reward, or entitlement? Compare your ideas with someone with more experience, someone from another country, someone from another field of study.
What is the “network of returns” that your college offers your instructor? What returns do you believe make a difference in teaching effectiveness? What “returns” would you change or add, to increase the teaching effectiveness?
page 30What are the four policy issues in the pay model? What purposes do the objectives in the pay model serve?
List all the forms of pay you receive from work. Compare your list to someone else’s list. Explain any differences.
Answer the three questions in the section Caveat Emptor–Be an Informed Consumer for any study or business article that tells you how to pay people.

Endnotes

 1. Written by Jenny Bradford and Berry Gordy Jr. Performed by The Beatles on The Beatles’ Second Album (1964).
 2. Brent Snavely, “Labor Costs to Be Sticking Point of UAW Talks with Automakers,” Los Angeles Times, July 8, 2011; Chris Woodyard, “VW Exec Knows of No Talks to Unionize Tennessee Plant,” USA Today, August 1, 2011; Jerry Hirsch, “Automakers Plan to Hire Thousands of Workers This Year,” Los Angeles Times, January 12, 2012.
 3. General Motors 2021 Annual Report (10-K); General Motors 2018 Annual Report (10-K), https:/./investor.gm; https://media.gm.com/media/us/en/gm/plants-facilities.html.
 4. W. G. Sanders and D. C. Hambrick, “Swinging for the Fences: The Effects of CEO Stock Options on Company Risk Taking and Performance,” Academy of Management Journal 50 (2007), pp. 1055–1078; Cynthia E. Devers, Gerry McNamara, Robert M. Wiseman, and Mathias Arrfelt, “Moving Closer to the Action: Examining Compensation Design Effects on Firm Risk,” Organization Science 19 (July-August 2008), pp. 548–566.
 5. Emily Glazer and Christina Rexrode, “As Regulators Focus on Culture, Wall Street Struggles to Define It,” The Wall Street Journal, February 2, 2015. p. A1.
 6. https://www.novartis.com/our-company/corporate-responsibility/ethics-risk-compliance/anti-bribery-anti-corruption. Accessed April 3, 2021; A. Kanski, “Novartis Revises Bonus Structure to Promote Ethical Behavior,” MM&M, September 21, 2018; J. Miller, “Novartis Links Bonuses to Ethics in Bid to Rebuild Reputation,” Reuters, September 17, 2018.
 7. B. Gerhart and M. Fang, “Pay, Intrinsic Motivation, Extrinsic Motivation, Performance, and Creativity in the Workplace: Revisiting Long-Held Beliefs,” Annual Review of Organizational Psychology and Organizational Behavior 2 (2015), pp. 489–521; B. Gerhart and M. Fang, “Pay for (Individual) Performance: Issues, Claims, Evidence and the Role of Sorting Effects,” Human Resource Management Review 24 (2014), pp. 41–52; K. F. Hallock, Pay: Why People Earn What They Earn and What You Can Do Now to Make More (Cambridge: Cambridge University Press, 2012); N. Gupta and J. D. Shaw, “Employee Compensation: The Neglected Area of HRM Research,” Human Resource Management Review 24, no. 1 (2014), pp. 1–4; G. E. Ledford, “The Changing Landscape of Employee Rewards: Observations and Prescriptions,” Organizational Dynamics 43, no. 3 (2014), pp. 168–179; B. Gerhart, S. L. Rynes, and I. S. Fulmer, “Pay and Performance: Individuals, Groups, and Executives,” Academy of Management Annals 3 (2009), pp. 251–315; B. Gerhart and S. L. Rynes, Compensation: Theory, Evidence, and Strategic Implications (Thousand Oaks, CA: Sage, 2003); James H. Dulebohn and Stephen E. Werling, “Compensation Research: Past, Present, and Future,” Human Resource Management Review 17 (2007), pp. 191–207; Steve Werner and Stephanie Ward, “Recent Compensation Research: An Eclectic Review,” Human Resource Management Review 14 (2004), pp. 201–227; S. L. Rynes, B. Gerhart, and K. A. Minette, “The Importance of Pay in Employee Motivation: Discrepancies between What People Say and What They Do,” Human Resource Management 43 (2004), pp. 381–394.
page 31 8. B. Gerhart, “Gender Differences in Current and Starting Salaries: The Role of Performance, College Major, and Job Title,” Industrial and Labor Relations Review 43 (1990), pp. 418–433; G. G. Cain, “The Economic Analysis of Labor-Market Discrimination: A Survey,” in Handbook of Labor Economics, ed. O. Ashenfelter and R. Layard (New York: North-Holland, 1986), pp. 694–785; F. D. Blau and L. M. Kahn, “The Gender Pay Gap: Have Women Gone as Far as They Can?” Academy of Management Perspectives, February 2007, pp. 7–23.
 9. U.S. Bureau of the Census. Historical Income Tables, Table P-40.
 10. Blau, F. D., & Kahn, L. M. (2017). The gender wage gap: Extent, trends, and explanations. Journal of economic literature, 55(3), 789–865.
 11. U.S. Department of Labor, Bureau of Labor Statistics, “Highlights of Women’s Earnings in 2010,” Report 1031, July 2011; Francine D. Blau and Lawrence M. Kahn, “The Gender Pay Gap: Have Women Gone as Far as They Can?” Academy of Management Perspectives 21 (February 2007), pp. 7–23.
 12. Daniel Kahneman and Angus Deaton. (September 21, 2010). High income improves evaluation of life but not emotional well-being. Proceedings of the National Academy of Sciences 107, 16489–16493.
 13. “Employer Costs for Employer Compensation—December 2020,” March 18, 2021, USDL-21-0437, www.bls.gov.
 14. Organization for Economic Cooperation and Development. OECD Health Statistics 2020 and Health Expenditures Funding. www.OECD.org. Accessed March 8, 2021.
 15. The Henry J. Kaiser Foundation, Julia Foutz, Anthony Damico, Ellen Squires, and Rachel Garfield, “The Uninsured: A Primer—Key Facts about Health Insurance and the Uninsured under the Affordable Care Act,” https://www.kff.org/uninsured/report/the-uninsured-a-primer-key-facts-about-health-insurance-and-the-uninsured-under-the-affordable-care-act/.
 16. National Center for Health Statistics. Fact Sheet, November 2020 (and previous years). www.cdc.gov; R.A. Cohen et al. Health Insurance Coverage: Early Release of Estimates from the National Health Interview Survey. January – June 2020. Released February 2021.
 17. Henry J. Kaiser Foundation, Key Facts about the Uninsured Population, September 19, 2017, updated November 29, 2017, https://www.kff.org/uninsured/fact-sheet/key-facts-about-the-uninsured-population/.
 18. John Gapper and Barney Jopson, “Coach to Cut Output in China,” Financial Times, May 13, 2011; Ben Blanchard, “Foxconn to Raise Wages Again at China Plant,” www.reuters.com, retrieved October 19, 2010; Joe Manget and Pierre Mercier, “As Wages Rise, Time to Leave China?” Bloomberg Businessweek, December 1, 2010; Shai Oster, “China’s Rising Wages Propel U.S. Prices,” The Wall Street Journal, May 9, 2011; Tim Worstall, “Apple’s Foxconn to Double Wages Again,” Forbes, May 28, 2012.
 19. David Redmon, director, Mardi Gras: Made in China, www.mardigrasmadeinchina.com/news.html; B. Powell and D. Skarbek, “Sweatshops and Third World Living Standards: Are the Jobs Worth the Sweat?” Journal of Labor Research, Spring 2006, pp. 263–290.
 20. L. Bebchuk and J. M. Fried, Pay without Performance (Cambridge, MA: Harvard University Press, 2004); M. J. Conyon, “Executive Compensation and Incentives,” Academy of Management Perspectives 21 (February 2006), pp. 25–44; S. N. Kaplan, “Are CEOs Overpaid?” Academy of Management Perspectives 22, no. 2 (2008), pp. 5–20; J. P. Walsh, “CEO Compensation: The Responsibilities of the Business Scholar to Society,” Academy of Management Perspectives 22, no. 2 (2008), pp. 26–33; A. J. Nyberg, I. S. Fulmer, B. Gerhart, and M. A. Carpenter, “Agency Theory Revisited: CEO Returns and Shareholder Interest Alignment,” Academy of Management Journal 53 (2010), pp. 1029–1049.
 21. Information on executive pay can be found in the following sources: Bruce R. Ellig, The Complete Guide to Executive Compensation, 3rd ed. (New York: McGraw-Hill, 2014); I. S. Fulmer, “Labor Market page 32Influences on CEO Compensation,” Personnel Psychology 62 (2009), pp. 659–696; B. Gerhart, S. L. Rynes, and I. S. Fulmer, “Pay and Performance: Individuals, Groups, and Executives,” Academy of Management Annals 3 (2009), pp. 251–315; C. Frydman and D. Jenter, “CEO Compensation,” Annual Review of Financial Economics 2 (2010), pp. 75–102; K. J. Murphy, “Executive Compensation,” in Handbook of Labor Economics, vol. 3B, ed. O. C. Ashenfelter and David Card (Amsterdam: Elsevier/North Holland, 2009).
 22. C. E. Devers, A. A. Cannella, G. P. Reilly, and M. E. Yoder, “Executive Compensation: A Multidisciplinary Review of Recent Developments,” Journal of Management 33 (2007), pp. 1016–1072; I. S. Fulmer, “The Elephant in the Room: Labor Market Influences on CEO Compensation,” Personnel Psychology, in press; A. Nyberg, I. S. Fulmer, B. Gerhart, and M. A. Carpenter, “Agency Theory Revisited: CEO Returns and Shareholder Interest Alignment,” Academy of Management Journal 53 (2010), pp. 1029–1049.
 23. Lucian Bebchuk, Alma Cohen, and Holger Spamann, “Paid to Fail,” Project Syndicate, March 2010. www.project-syndicate.com, retrieved May 18, 2012; Lucian Bebchuk et al., “The Wages of Failure: Executive Compensation at Bear Stearns and Lehman 2000–2008,” Yale Journal on Regulation 27 (2010), pp. 257–282.
 24. Joann S. Lublin, “Firms Feel ‘Say on Pay’ Effect: Companies Work Harder to Win Shareholder Votes on Executive Compensation,” The Wall Street Journal, May 2, 2011; Gretchen Morgenson, “When Shareholders Make Their Voices Heard,” The New York Times, April 7, 2012; Steven M. Davidoff, “After $2 Billion Loss, Will JPMorgan Move to Claw Back Pay?” The New York Times, May 14, 2012, https://dealbook.nytimes.com/2012/05/14/after-2-billion-trading-loss-will-jpmorgan-claw-back-pay
 25. Apple 2020 Progress Report. Supplier Responsibility. https://www.apple.com/supplier-responsibility/pdf/Apple_SR_2020_Progress_Report.pdf.
 26. Wayne F. Cascio, “The High Cost of Low Wages,” Harvard Business Review 84 (December 2006), p. 23; Liza Featherstone, “Wage against the Machine,” Slate, June 27, 2008.
 27. Costco 10-K (annual report), filed October 14, 2011; Walmart 10-K (annual report), filed March 27, 2012.
 28. Jerry Newman, My Secret Life on the McJob (New York: McGraw-Hill, 2007); Edward Lawler III, Treat People Right! How Organizations and Individuals Can Propel Each Other into a Virtuous Spiral of Success (San Francisco: Jossey-Bass, 2003).
 29. K. Bartol and E. Locke, “Incentives and Motivation,” chap. 4 in Compensation in Organizations, ed. S. Rynes and B. Gerhart (San Francisco: Jossey-Bass, 2000), pp. 104–150; B. Gerhart, S. L. Rynes, and I. S. Fulmer, “Pay and Performance: Individuals, Groups, and Executives,” Academy of Management Annals 3 (2009), pp. 251–315.
 30. Edward E. Lawler III, Pay and Organizational Effectiveness: A Psychological View (New York: McGraw-Hill, 1971); T. L. P. Tang, “The Meaning of Money Revisited,” Journal of Organizational Behavior 13, no. 2 (1992), pp. 197–202.
 31. E. P. Lazear, “Salaries and Piece Rates,” Journal of Business 59 (1986), pp. 405–431; B. Gerhart and G. T. Milkovich, “Employee Compensation: Research and Practice,” in Handbook of Industrial & Organizational Psychology, 2nd ed., ed. M. D. Dunnette and L. M. Hough (Palo Alto, CA: Consulting Psychologists Press, 1992); B. Gerhart and S. L. Rynes, Compensation: Theory, Evidence, and Strategic Implications (Thousand Oaks, CA: Sage, 2003).
 32. D. M. Cable and T. A. Judge, “Pay Preferences and Job Search Decisions: A Person-Organization Fit Perspective,” Personnel Psychology 47 (1994), pp. 317–348; C. B. Cadsby, F. Song, and F. Tapon, “Sorting and Incentive Effects of Pay-for-Performance: An Experimental Investigation,” Academy of Management Journal 50 (2007), pp. 387–405; C. Q. Trank, S. L. Rynes, and R. D. Bretz, Jr., “Attracting page 33Applicants in the War for Talent: Differences in Work Preferences among High Achievers,” Journal of Business and Psychology 16 (2001), pp. 331–345; C. O. Trevor, B. Gerhart, and J. W. Boudreau, “Voluntary Turnover and Job Performance: Curvilinearity and the Moderating Influences of Salary Growth and Promotions,” Journal of Applied Psychology 82 (1997), pp. 44–61; A. Salamin and P. W. Hom, “In Search of the Elusive U-Shaped Performance-Turnover Relationship: Are High Performing Swiss Bankers More Liable to Quit?” Journal of Applied Psychology 90 (2005), pp. 1204–1216; J. D. Shaw and N. Gupta, “Pay System Characteristics and Quit Patterns of Good, Average, and Poor Performers,” Personnel Psychology 60 (2007), pp. 903–928; B. Schneider, “The People Make the Place,” Personnel Psychology 40 (1987), pp. 437–453; A. Nyberg, “Retaining Your High Performers: Moderators of the Performance-Job Satisfaction-Voluntary Turnover Relationship,” Journal of Applied Psychology 95 (2010), pp. 440–453; J. D. Shaw, B. Dineen, R. Fang, and R. F. Vellella, “Employee-Organization Exchange Relationships, HRM Practices, and Quit Rates of Good and Poor Performers,” Academy of Management Journal 52 (2009), pp. 1016–1033; M. Lynn, R. J. Kwortnik, and M. C. Sturman, “Voluntary Tipping and the Selective Attraction and Retention of Service Workers in the USA: An Application of the ASA Model,” International Journal of Human Resource Management 22 (2011), pp. 1887–1901; T. Dohmen and A. Falk, “Performance Pay and Multidimensional Sorting: Productivity, Preferences, and Gender,” The American Economic Review 2011, pp. 556–590; B. Gerhart and M. Fang, “Pay for (Individual) Performance: Issues, Claims, Evidence and the Role of Sorting Effects,” Human Resource Management Review 24 (2014), pp. 41–52; B. D. Blume, R. S. Rubin, and T. T. Baldwin, “Who Is Attracted to an Organisation Using a Forced Distribution Performance Management System?” Human Resource Management Journal 23, no. 4 (2013), pp. 360–378; W. J. Becker and R. Cropanzano, “Dynamic Aspects of Voluntary Turnover: An Integrated Approach to Curvilinearity in the Performance-Turnover Relationship,” Journal of Applied Psychology 96 (2011), pp. 233–246; B. W. Swider, W. R. Boswell, and R. D. Zimmerman, “Examining the Job Search-Turnover Relationship: The Role of Embeddedness, Job Satisfaction, and Available Alternatives,” Journal of Applied Psychology 96 (2011), pp. 432–441.
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 73. Readers of earlier editions of this book will note that we now at times substitute “fairness” for “equity.” The word “equity” has taken on several meanings in compensation, such as stock ownership and pay discrimination. In some cases, “fairness” better conveys our meaning in this book.
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