Mitovich-Nowman | Liew! Aignnene | 3. Detiig lata © teMew Ht Compensation Eighth Osferining the Sacre Aigner! Carin, lion Chapter Three Defining Internal Alignment Chapter Outline Compensation Strategy: Internal Internal Labor Markets: Combining Alignment External ond Organiaton Factors Supports Organization Srateg Employee Accepance: A Key Factor Supports Work Flow Strategic Choices in Designing internal Supports Fairness structures Motivates Behavior Tailored versus Loosely Coupled Structures Vary among Organizations Faria versus Herarchical Levels Career Path Differentials Differentials What tho Research Tolls Us Criteria Exuity Theory What Shapes internal Structures? Tournament Theory Economic Pressures Institut Model: Cony Others Government Policies, Las, and Which Structure Fits Best? Regulations Consequences of Structures External Stakeholders Efficiency: Competitive Advantage Guitres and Customs Fairness Orguniaton Stategy Compionce 's Human Capital Your Turn: So You Want to Lead Organization Work Design the Orchestra! Overall HR Policies For the kingdom of heavens ike a householder who went ou eal inthe morning to hire laborers for his vineyard. And having agreed with the laborers for a denaris «day, he sent them into his vineyard, And about the third hour, he went out and saw otbers stand idle; and he said to them, “Go you also into the vineyard, and Twill give you whatever is just” ‘And again he wen oat about the ninth hour, and did as before .. . ut about the eleventh hour he went out and found otbers . . and he suid wo them, “Go you als into the vineyard” When eveni came, the owner sid to his steward, “Call te laborers, and pay them thee ‘wages beginning from the las also received each is denarius. .. . They began to murmur against the householder, saying, These last have worked a single hour, and thou hast pat them on level with us, who have tothe fr.” When the frst in ther tur ca they 39[ inovict-tewmac: | Liner Agumese | 3. Defining tra Tememimw-it Conpenstin Eghth ——Detriing teSectre— Agamat Ccnin 24 Kien 60, PartOne Ina Alignment: Determining he Sucre bome the burden ofthe day's hea.” But answering them, he said, “Friend, Ido thee no injustice; take what is thine and po." Matthew's parable raises age-old questions about internal alignment and pay struc- tures within a single organization? The laborers felt that those “who have borne the bur- den of the day's heat” should be paid more. But pechaps the householder was using a dif= ferent criterion: an individval’s needs without oyard to time worked or tasks performed.* Matthow docsn’t toll us how the work in the vineyard was organized. Perhaps laborers ‘worked in teams, with some trimming and others tying the vines. Doss trimming require more judgment than tying? Today's pay structures are typically designed by assessing the content ofthe work, the skills and knowledge required to perform it, and its relative value for achieving the orga nization's objectives. The procedures to do this must be acceptable to the patties in- volved. Ifnot, today’s managers and employees murmur, too. That murmuring translates into tumover, unwillingness to try new technologies, and even an indifference to the quality of the grapes or the customers satisfaction with them. This chapter examines in- temal alignment and its consequences. COMPENSATION STRATEGY: INTERNAL ALIGNMENT Setting objectives was our first issue in a strategic approach. Our second, internal align= ‘mont, addresses relationships inside the organization. How do the responsibilities and pay of a trimmer versus tyer relate to cach other? How do they relate to the responsibilities and pay of the houscholder's cook or the steward? Internal alignment addresses the logic underlying these relationships. Internal alignment, often called internal equity, reer to the pay relationships among Afferent obs/skill/competoncies within a single organization The elatonships fom pay structure that should support the organization strategy, support the work flow, be fa Toemployees, and motivate behavior toward organization objectives. Exhibit 3.1 shows a structure for the engineering work at a division of Lockheed Mar- tin, the world’s largest defense contractor. Lockheed also builds rockets, shuttles, and rovers for NASA. The six levels in Lockheed’s structure range from entry to consultant. You can see the relationships in the descriptions of each level of work. Decisions on how such to pay the six levels create a pay structure, ‘Matthew 20: 1-16. 2For a history of the ferent stands for pay, see Thomas Mahoney, Compensation and Reward Perspectives (ut Ree, I Iin, 1979), G. Milowch and. Stevens, “From Pay to Reaards: 100 Years of Change,” ACA Journal 81) (2000), pp, 6-18: DF. Schioss, Methods m Industrial Remuneration (New York: Putnam's, 1892, 2Seveal Japanese fms sillbase a small potion ofa worker's pay onthe number of dependents, In the ay 1900s, workers who were “Tarly men” received a pay supplement in Some US. fms as wel, The itn rice bow,” which uni recently prevailed in China's state enterprises, provided entire famies with cradleto-grave wettare “Equity” could refer to stock, o some perceived balance of effort and rewards, andor pay crimination (gender equity). We believe “interna lignment" better reflects the meaning and importance underyng pay structures.Teton Conais, 24 Chapter 3 Defi eer Aiganear 61 Entry Level Engineer Engineering Limited use of basic principles and concepts. Develops solutions Structure at tolmited problems. Closely superse. Lockhced feck Senior Engineer Ful use of standard principles and concepts. Provides solutlons to varity of problems. Under general supervision systems Engineer ‘Wide applications of principles and concepts, plus working knowledge of other related disciplines, Provides soluttons to a ‘wide variety of difficult problems. Solutions are imaginative, thorough, and practicable. Works under only very general direction ead Engineer ‘Applies extensive expertise as a generalist or specials. Develops solutions to complex problems that requice the regular use of ingenuity and creativity. Work is performed ‘without appreciable direction. Exercises considerable latitude in determining technical objectives of assignment. Advisor Engineer ‘Applies advanced principles, theories, and concepts. Contributes to the development of new principles and concepts. Works on unusually complex problems and provides, solutions that are highly innovative and ingenious. Works under consultative direction toward predetermined long-range (goals, Assignments are often sef-nitiated. Consultant Engineer Exhibits an exceptional degree of ingenuity, creatity, and resourcefulness. Applies and/or develops highly advanced technologies, scientific principles, theories, and concepts. Develops information that extends the existing boundaries of i knowlexige ina gven field, Often acts independently to Recognized incover and resolve problems associated with the development ‘Authority and implamantation of operational programs. Pay structure refers to the array of pay rates for alfferent work or sits within a single ‘organization, The number of levels the fferentialsn pay between the levels, and the: criteria used to determine those differences describe the structure. Supports Organization Strategy Fundamentally, organizations exist for a purpose (profits, not-for-profits, government agencies, and so on). The organization’s strateyy tells us how it plans to achieve its pur- pose, Internal structures that are aligned with a strategy help achieve it. Lockheed decided that six levels of engineering work would support the research, design, and development of advanced technology systems to achieve the company's objectives. The householder's[ inovict-tewmac: | Liner Agumese | 3. Defining tra Tememimw-it Conpenstin Eghth ——Detriing teSectre— Agamat Ccnin 24 Kien 62, PartOne InemalAlgrment: Determining the Sucre jemal pay structure may have been aligned with his business strategy, but the employee dissatisfaction raises concerns about its fairness to employees. Supports Work Flow Work low refers to the process by which goods an services are detivered tothe customer. The pay structure ought to support the efficient flow of that work and the design of the organiaa- tion For example, drug companies traditionally base the size of their sales forces on the num- ber of physicians to be called on per day and the number of working days per year. The U.S. drug manufacturer Merck decided to take a nontraditional apprcach to omzanizng sales and marketing. Merck ereated teams of account executive, client representatives, and medical ine formation scientists to serve a broader clicncl of health maintenance organizations, insurance companies, and physicians. A crostfunctional team responsible fora distint geographic aca (cathor than a list of physician-clients) provides a relationship-building approach to selling products. Rather than hawking a specific drug and giving out free samples, the Merck tears ane a source of knowledge for the physicians and the health organizations. The teams keep clients apprised of rogulations and cover drugs for a wider range of medical conditions. One team even translated brochures that explain a course of treatment into Chinese, Russian, and Spanish fora physician whose patients included non-Engish-spoaking immigrants. Such a re- ‘sponse would have been beyond the resources of a single sales representative under Merck's old approach. (Ofcourse, the brochure recommended treatment with Merck products.) To support these work teams, Merck designed a new compensation structure. The pay differences between account executives customer representatives, and medical informa- tion scientists who served on the same teams were a major issue—just as they are for Lockheed engineers and just as they likely are forthe east of Everwood. Think globally, Ford Motor does. Ford acquired Volvo (Sweden), Jaguar and Land Rover (Britain), and most of Mazda Japan). To leverage its now engineering and manu- facturing knowledge, Ford is creating global teams. This changes the work flow and or- ganization design at Ford. Ford also needs to rethink pay structures to be suze they supe port the new global teams. Global pay structures create special challenges du to different wages and benefits paid for the same jobs in different parts of the world. Later chapters will discuss various ways companies manage this challenge. Supports Fairness ‘An intemally aligned pay structure is more likely to be judged fur i it is based on the work and the skills required to perform the work and if people have an opportunity to be involved in some way in determining the pay structure® 31, Shaw, N. Gupta, and JE. Delay, “Pay Dispersion and Workforce Performance: Moderating Effects Of incentives and interdependence,” Suategic Management 23 (2002), pp. 491-512: RA. Guzzo and IM.W. Dikson, “Teams in Organzations: Recant Research in Parformance and Effecweness,” Annual Review of Psychology 47 (1996), pp. 307-338. Marca P. Mico and Paul Muley, "Satisfaction vith Pay Systems: Antecedents and Consequences, Industrial Relations aruary 2000), 391); G. Hundley and J. Kim, “National Cute and the Factors Affecting Perception of Pay Faimesin Korea and the U.S,” Intemational Journal of Organization “Analysis 5, pp. 325-241; M.A. Koncvsty, “Understanding Procedural Justice and its Impact on Business Organizations" Joumaf of Management 26() (2000), pp. 489-511; Foard F_ ones, Vida Scarpello, and Tamas Bergmann, "Pay Procedues What Makes Them Fa?" Joumal of Occupational and (Organizational Pachology 72 (1999), pp. 129-145,Fei Nowa: Compensation Eth Tint Agana Tena i Detriing he Scere Agent Campi 204 CChapter'3 Defi Incral Aliment 63 Two sources of fimess are important: the procedures for determining the pay structure, called procedural justice: and the results of those procedures—the pay structure itself called iserbutive justice. Suppose you are given a ticket for speeding. Procedural justice refers to the process by Which a decision is reached: the right to an attorney, the right to an impartial judge, and the right to reccive a copy of the arestng officers statement, Distributive justice refers to the faimess of the decision: guilty. Researchers report that employees’ perceptions of procedural fairness significantly influence their acceptance ofthe results; employees and ‘managers are more willing to accept low pay if they believe thatthe way this result was obtained was fait. This esearch also suggests that pay procedures are more likely to be perceived as fair (I) if they are consistently applied to all employees, (2) if employees participated in the process, (3) if appeals procedures are included, and (4 if the data used are accurate. Nevertheless, a never study raises a question about the usefulness of em- ployee participation.” In a low-wage company, there was no connection between em- ployee participation and pay fairness. It may be that employees were paid so low that no amount of participation could overcome their dissatisfaction. So rather than tossing aside the idea of panicipation, it may be that in extreme cases (very low waues), a pay raise ‘may tump participation, ‘Applied to internal structures, procedural justice addresses how design and administa- tion decisions are made and wether procedures are applied in a consistent manner. Dis- tributive justice addresses whether the actual intormal pay differences among employees are reasonable.’ Motivates Behavior Internal pay structures are part ofthe network of rewards discussed in Chapter I: pay ine creases for promotions bigger tiles, more challenging work. The challenge isto design the structures so that they engage people to help achieve organization objectives. Merck ‘marketing teams work together ta share unique knowledge with each other and with their clients. Lockheed engineers do, too. And so do the writers, actors, and crew on Ever~ ‘wood. The structute ought to make clear the relationship between each job and the orga- nization’s objectives.’ This is an example of “line-of-sight.” The more employees can “sce” or understand links between their work, the work of others, andthe orvanization’s objectives, the more likely they wil be to achieve those objectives. "frederick P. Moroeson, Michael A. Campion, Car P. Maerz, “Understanding Pay Satisfaction: The Limits of a Compensation System implameniaton "Journal or Business & Psychology Fal 16(1) (2001), pp. 133-163 ®Egiberto F. Montemayor, "Decsianal and interactional Fairness: Supervisor Influence on Merit Pay Satstacton,” Management Research: The Journal ofthe Iberoamencan Academy of Management 1@) (Spring 2002), pp. 145-160; Foard F. Jones, Vida Scarpelo, and Thomas Beramann, “Pay Procedures—What Makes Them Far?" foul of Occupational aed OrganwationalPsycalogy 72 (1928), pp. 129-145, SAH. Thaker, “From Home Economics to Homo Sapiens,” Journal of Economic Perspectives 141) (Winter 2000), pp. 133-141; Rosemary Bat, Alexander JS. Coli, and Jtfray Keefe, “Employee Voice, Human Resource Practices, and Quit Rates: Evdence from the Telecrmunications Indust,” Industral _and Labor Relations Review 5514) Uuly 2002), pp. 573-594; Casey Icniowsk, Kathryn Shaw, and Jon Gram, “Working Smarter by Working Together: Connective Capital inthe Workplace,” working pape, Columbia University, New York, 2002,[ ihavict-tewmane | Linen Agama | 3. Dei tra Tememimw-it Conpenstin Eghth ——Detriing teSectre— Agamat Ccnin 24 Kien 64 PartOne Inxmal Aliment: Dering he Senco STRUCTURES VARY AMONG ORGANIZATIONS ‘An internal pay structure can be defined by (1) number of levels of work, 2) the pay differen ‘als between the levels, and (3) the erteria used to determine those levels and differentials Levels One feature of any pay structure is its hierarchical nature: the number of levels and re- porting relationships. Some are more hierarchical, with multiple levels; others are com- pressed, with few levels. GE Plastics engineers thermoplastic resin “solutions.” (With so many companies offering “solutions.” are we running short of problems?) In compari- son to Lockheed’ six levels for engineering alone (Exhibit 3.1), GE Plastics uses five broad levels, deseribed in Exhibit 3.2, to cover engineering as well as all professional and executive work. GE Plastics would probably fit the Lockheed Martin structure into two or three levels. Differentials ‘The pay differences among levels are referred to as differentials. If we assume that an or- ganization has a compensation budget of a set amount to distribute among its employees, there are a number of ways it ean do so. It can divide the budget by the number of em ployzes to give everyone the same amount. The Moosewood Restaurant in Ithaca, New York, adopts this approach. But few organizations in the world are that egalitarian. In most, pay varies among employees." Work that requires more knowledge or skills, is performed under unpleasant working conditions, and/or adds more value is usually paid EXHIBIT 3.2 Managerial level pan Proheoiash Brecutwe Provides vision, leadership, and innovation to major Levees ‘business segments or functions of GEP creda Director Directs a significant functional area or smaller business General Eagan Electric Leadership. Individual contruters leading projects or programs with Plastics bbroad scope and impact, or managers leading functional (GEP) ‘components with broad scope and impact Technicalimanagerial _—_Indvidual contributors managing projects or programs ‘with defined scope and responsiblity, or fst-tler ‘management ofa specialty area, Professional ‘Supervisors and individual contributors working on tasks, activities, and/or ess comple, shorter-duration projects "Michael Gib, “Incentive Compensation in a Corporate Hierarchy,” Jounal of Accounting and Economics 19 (1995), pp. 247-277. "Researchers usea static called the gin coefficient a describe the dstibution of pay. A gini of zero ‘means everyone i paid the identical wage. The higher the gin coefficient (maximum = 1), the greater the pay diferent among the lveFei Noa: Companion Eth Criteria Teton Conais, 24 [inet Aga Detriing he Sct Chapter 3 Defining ema Alganent 65 more. Exhibit 3.3 shows the differentials attached to Lockheed Martin's engineering structure. The intention of these differentials is to motivate people to strive for promotion to.a higher-paying level. Content and Value Content refers to the work performed in a job and how it gots done (tasks, behaviors, Knowledge required, ete.) Value refers to the worth of the work: its relative contribution to the organization objectives. A structure based on content typically ranks jobs based on skills required, complexity of tasks, and/or responsibility. In contrast, a structure based on the value of the work facuses on the relative contribution of the skills, tasks, and respon- sibilities of a job to the organization's goals. While the resulting structures may be the same, there are some important differences. In addition to including relative contribution, value may also inelude external market pressures (ie., what competitors pay for this level of contribution). Or it may include rates that have been agreed upon through collective bargaining, or even legislated rates (minimam wage). Job values across all organizations in Cuba are sot by a government agency. Following the now-iscarded approaches of the former Soviet Union and China, Cuba’s government dictates a universal structure: 8 lev- els for industrial workers, 16 levels for technical and engineering work, and 26 levels for government employees. Use Value and Exchange Value Use value rofleets the value of goods or services an employee produces in a job. Exchange value is whatever wage the employer and em- ployee agree on for a job. Think about IBM software engineers living in Bangalore, Kiev, and Purchase, New York. Now think about thom working together on the same project — ‘same company, same job content, same internal job value. Same use value. Yet they are in vory different geographies and external markets. Wage rates in Bangalore and Kiev are alot less than in Purchase. The exchange value varies.’ For promotions, IBM treats these jobs as being at the same level in the structure. Bur the competitive practices and markets in India, the Ukraine, and the United States yield very different pay rates.!! The difference between exchange value and use value also surfaces when one firm ac- quires another. IBM's acquisition of PricewaterhouseCoopers (PWC), where consultants were the lifeblood of the company, is a case in point. PricewaterhouseCoopers consultants added more knowledge to IBM's marketing teams. But the use value oftheir knowledge within [BM " Barry Gerhart and Sara Rynes, Compensation: Theory, Evidence, and Strategic Implications (Mousa (Oaks, CA: Sage, 2003); Robert Gibbons and Michael Waldman, "A Theory of Wage and Promotion| Dynamics inside Firms," Quarter Journa of Economics, Novernber 1909, pp. 1321-1258; George Baker, ‘Michael Gibbs, and Bengt Holmstvom, "The Internal Economic of the Fm: Evidence rom Perse Data,” Quarterly Journal of Economics, November 1934, pp. 881-919; M. Bloom and G. Mikovich, ‘Money, Managers, and Metamorphosé, in Trends in Organizational Behavior, 3d ed, eds. D. Rousseau and C. Cooper ew York: Wey, 1996). ®David Kirkpatrick, “The Net Makes It ll Easie—Incuding Exporting US, Job,” Fortune, May 26, 2003, . 146; LauneBienstock and Sandra McLellan, “Job Leveing ina Changing Environment: Does Your (Organvaton Measure Up?” WorldatWork Journal 11(8) Fourth Quarter 2002), wow workdatWork. or “Towers Perrin and ather consulting fms offer extensive global surveys: nw towers comtowersitpdatat[ ihavict-tewmane | Linen Agama | 3. Dei tra Tenavetiw in Comin th Orca Sects Agent finan 4 tae 66 PartOne Ins Aken Peeing Sc EXHIBIT 3.3 Engineering Pay Structure at Lockheed Martin A —8162.000_ Consultant 140,000 Engineer 337.000 G0%) 130,000 1s.000 Advisor 120.000 Engineer 327,000 10000 (08%) 100,000 Lead Engineer 0,000 $2,000 (06%) 80.000 15,000 70.000 04%) «000 11,000 it) 50,000 20,000 Es} —_—________| Recognize Authority Differentials Between LevelsFei Noa: Companion Eth [timation | [Link] ntl Tememaw-it Detriing he Scare Alguet Conais, 24 Chapter 3. Defining ema Algmnent 67 differs from that within PWC. So basically similar job content in 1wo different companies may be valued differently based on how it contributes to organization objectives. Altema- tively, the same work content in the same company (IBM’s software engineets) may have dif- ferent exchange values based on the different geozraphies. Job- and Person-Based Structures A Job-based structure relies on the work content—tasks, behaviors, responsibilities. A person-based structure shifts the focus to the employee: the skills, knowledge. ar compe- ‘encies the employee possesses, whether or not they are used in the employee’s particular Jjob.!S The engineering structure at Lockheed Martin (Exhibit 3.1) uses the work per- formed as the criterion. GE Plastics (Exhibit 3.2) uses the individual employees’ compe tencies required at each level of work. In the real world, itis often hard to describe a job without reference to the jobholder’s knowledge and skills. Conversely, itis hard to define a person's job-related knowledge or competencies without referring to work content. So rather than a job- oF person-based structure, reality includes both job and person. WHAT SHAPES INTERNAL STRUCTURES? ‘The major factors that shape internal structures are shown in Exhibit 3.4, We eateyorize them as external and organization factors, even though they are connected and interact- ing. Exactly how they interact is net well understood. As we discuss the factors, we will, also look at various theories. Economic Pressures ‘Adam Smith was an early advocate of letting economic market forces influence pay structures. He was the first to ascribe both an exchange value and a use valve to human resources. Smith faulted the new technologies associated with the Industrial Revolution for increasing the use value of labor without a corresponding inerease in exchange value (ic, higher wages for workers) Karl Marx took this exticism even further.6 He said that employers unfairly pocketed the surplus value created by the difference between use value and exchange value. He luged workers to overthrow capitalistic systems to become ownets themselves and reap the fll use value of their labor. ‘A countering theory put forth inthe last half ofthe 19th century, marginal productivity, says that employers do infact pay use value.” Unless an employee ean produce a value «qual to the value received in wages it will nt be worthwhile to hire that worker. Pay dif ferences among the job levels reflect differences in use value associated with different 'SE.E. Lawler, *Fom Job-Based to Competency-Based Organizations,” Journal of Organization Behavior 15 1984), pp. 3-15 "WC. Tucker, ed, The Manc Engels Reader (New York: Norton, 1978) "Aan M. Carter, Theory of Wages and Employment Bur Ridge, I: win, 1959),[ inovict-tewmac: | Liner Agumese | 3. Defining tra Temavesin- + Compenaton gh Dstrmning th Sacre Agar! Conan 4 {68 Part One Inca Aliment: Determining te Smutie EXHIBIT 3.4 What Shapes Internal Structures? jobs. One job is paid mote or less than another because of differences in relative produc tivity ofthe job andior differences in how much a consumer values the output. Hence, df= ferences in productivity provide a rationale forthe internal pay structure. In addition to supply and demand for labor, supply and demand for products and ser- ‘vices also affect internal structures. Rapid, often turbulent changes, either in competitors’ products/servies (asin the rise ofthe Internet for making purchases) or in customers’ tastes (asin the popularity of sport-uility or low-emission vehicles), force organizations to redesign work flow and foree employees to continuously learn new skills. Turbulent, 1Fei Noa: Companion Eth Teton Conais, 24 [inet Aga Detriing he Sct Chapter 3 Define uemal Algmnent 69 Unpredictable external conditions require pay structures that support agile orga and flexible people.!° Government Policies, Laws, and Regulations In the United States, equal employment legislation forbids pay systems that discriminate on the basis of gender, race, religion, oF national origin. The Equal Pay Act and the Rights Act require “equal pay for equal work,” with work considered equal if it requires equal skill, equal effort, and equal responsiblity and if itis performed under equal work- ing conditions. An internal structure may contain any number of levels, with differentials of any size, as long as the criteria for setting them are not gender, race, religion, or na- tional origin, Much pay-related legislation attempts to regulate economic forces to achieve social welfare objectives. The most obvious place to affect an internal structure is at the mini- ‘mums (minimum-wage legislation) and maximums (special reporting requirements for executive pay). But legislation also aims at the differentials. A contemporary U.S. exam- ple is the “living wage-""” A number of US. cities require minimum hourly wage rates well above what federal law requires. The anticipated outcome of such legislation is a flatter, more compressed structure of waze rates in society. We have already described the mandated pay structures in Cuba. Cuba wasn't alone. Until recently, an entire government agency in the Slovak Republic in eentral Europe was devoted to maintaining a 15-level pay structure that was required in all Slovak companies (but not forcign ones). The detailed procedures manuals and job descriptions filled a ‘number of shelves. People dissatisfied with the pay rate for their jobs could appeal to this agency. Not surprisingly, few did. Recent reforms offer greater freedom to companies and unions to negotiate pay structures. External Stakeholders Unions, stockholders, and even political zroups have a stake in how internal pay structures are determined. Unions are the most obvious case, Most unions seek smaller pay differ- ences among jobs and seniority-based promotions as a way to promote solidarity among members. At the minimum, unions want the interests oftheir members represented. In the United States, the AFL-CIO uses information on the pay differeness between top execu tives and employees to rally support for union membership (see [Link]). "4G. Milkovic and M1. Bloom, “Rethinking ntematianal Compensation: Frm Expats and National Cultures to Strategic Fenty,” Compensation & Benefits Review, Ssue 1, 1998; S. Brow and .sonhardt, Competing on the Edye: Suategy and Structured Chaos (Boston Harvard Busnes Press, 1988); George Baker, Michael Gibbs, ad Bengt Holmstrom, “The Internal Economics of the Fr idence from Personnel Dats,” QuarteryJoumal of Economics November 1994, pp. 881-319; Ginds, “incente Compensation in 2 Corporate Hierarchy," Journal of Accounting and Economics 19 (1995), pp. 267-277 "Scott Adams and David Neumark, “Ling Wage Effects: New and Improved Evidence,” NBER working paper 9702, 2003 201 Bloom, G. Mikevich, and A. Mita, "Intemational Compensation’ Learing rom How Managers Respond ta Variations in Lacal Host Contes,” ternational Human Resource Managemeat Gn ples): 'M. Mendenhall and G. Oddou, Readings and Cases n Intemational HRM (Cincinnati: Soutnwester, 2000)[ inovict-tewmac: | Liner Agumese | 3. Defining tra Tememimw-it Conpenstin Eghth ——Detriing teSectre— Agamat Conic, 24 Kien 70 Part One Ina Algrment: Determining the Sucre Stockholders pay attention to the gap between executive and employee pay. The $6 million cash compensation (plus stock options worth $197 million) for Disney CEO Michael Bisner stands in sharp contrast to that earned by Disney employees who perform as Mickey or Minnie Mouse. Mickey, Minnie, Pluto, Goofy, and even Snow White cam union rates of between $18 and $25 an hour. (Yes, Mickey and Minnic are Teamsters.) Shareholders of several companies ranging from General Electric to Glaxo Smith Kline are beginning to pressure companies to control or at least better justify exee- tive pay. Research is beginning to determine the effects ofthese pay differentials on em- ployees’ behaviors and performance and, consequently, organization performance?! Cultures and Customs Garrison Keillor defines culture by what songs we know in common—camp songs, slic ious hymns, the big hits ofthe year we were 15. A more academic definition of eulture is the mental programming for processing information that people share in common? Shared mind-sets may judge what size pay differential i fair. In ancient Greece, Plato de- clared that socities are strongest when the richest eared a maximum of four times the lowest pay. Aristotle favorod a fivectimes limit. In 1942 President Franklin Roosevelt proposed a maximum wage: a 100 pereent fax on all income above 10 times the mini- mum wage. Historians tellus that in L4th-century western Europe, the church endorsed a “just wage” doctrine, a structure of wages that supported the existing elas structure. The doc- Urine was an effort to end the economic and social chaos resulting from the death of one- third of the population from plague. The shortage of workers that resulted gave common people power to demand higher wages, much to the dismay of church and state. Market forces such as skills shortages (higher exchange value) were explicitly denied as appro- priate determinants of pay structures. Today, advocates of the living wage are trying to change sovetal judgments about what wage is just Even today cultural factors continue to shape pay structures. Many traditional Japan- ese employers place heavy emphasis on seniority in theie internal pay structures. But pressures from global competitors plus an aging work force have made age-based pay 2 ichae![Link], “Corporate Toumaments," Jour of Labor Economics, 192) 200, pp. 290-215; ‘Mason A. Carpentar and lames B. Wade, “Micrel Opportunity Structures as Determinants of Non- CEO Executive Pay,” Academy of Management Journa' 6 (2002), pp. 1085~1103, 2c. Hoetstede, Cultures Consequences: Internationa! Diferences in Work Relationships and Values (Thousand Oaks, CA: Sage, 1980); R. Donkin, “The Peckng Orders rstinctive Appeal,” Financial Times, ‘August 23, 2002; A Miva, M. Bloom, and G. Mikevich, "Crossing a Raging Rive: Seeking Fa-Raaching Solutions to Global Pay Challenges," WorldatWork Journal, 11(2) (Scand Quarter 2002); F. Trompenaas, Aiding tbe Waves of Culture: Understanding Divers in Global Business Bur Ridge Lwin, 1935} J. Brocknes, . Chen, K Leung, and [Link], "Culture and Procedural Fimess. When te Efects of What You Do Depend on How You Ba i,” Administrative Science Quarter 45 (2000), pp. 138-159, Thomas i-ng Tang Vienne Wal Mel Luk, and Randy K. Chiu, "Pay Different inthe People's Republic fof China: An Examination of intemal Equty and Exteal Compatituenes,” Compensation and Benefits Review 32(3) (Mayune 2000), pp. 43-48: ling-in Fah, Chen-B0 Zhang, and Dennis W. Organ, "Organizational lizenshp Behavior inthe People’s Republic of China,” in Organation Science special Issue: Corporate Trarsfrmations i Chia Gr oes)Fei Noa: Companion Eth Teton Conais, 24 [inet Aga Detriing he Sct Chapter 3 Defining Item Aligonent 71 structures very expensive. Consequently, some Japanese employers are emphasizing per formance and downplaying seniority." This change is particulary irksome; as we have grown older the wisdom of basing pay on age has become more obvious to us. Organization Strategy You have already read how organization strategies influence internal pay structures. The basic belief of a strategic perspective is that pay structures that are not aligned with the ‘organization strategy may become obstacles to the organization's suecess. Organization's Human Capital Human capital—the education, experience, knowledge, abilities, and skills that people possess—is a major influence on internal structures. The stronger the link between the skills and experience a person possesses and an organization's objectives, the more pay those skills will command, Lockheed’s structure pays consultant engineers more than lead or senior engincers because the human capital of consultant engineers brings a greater return to Lockheed. Itis more erueial to Lockheed’ success. Organization Work Design Technology used in producing yoods and services influences the organizational design, the work to be performed, and the skill/bnowledge required to perform the work The teche nology required to produce precision military hardware differs from that used to manutac- ture plastics. Defease contract work is more labor-intensive (mate than 50 percent of oper- ating expenses are labor costs) than is plastics (ess than 20 percent; hence, different structures emerge. Apparently the engineering labor costs for Mars rovers and military ‘weapons excsed those for engineering the coatings for such products as DVDs, automobile parts, building, materials, and bullets. Lockheed uses six levels for engineering alone, ‘whereas GE Plastics uses five levels for all managerial professional echnical employces. ‘The design of organizations is undergoing profound changes. According to Drucker, “A staggering number of people who work in organizations are no longer traditional employ. 2s ofthese organizations." These “nonemployees” are employed by someone—either a supplier of information technology services (e.2, IBM or Hewlett-Packard) or pechaps a 2Yoshio Yanador and George Mikovch, “Minimizing Wage Competition? Entry-Level Compensation in Japanese Fm," working paper, Center for Advanced HR Stakes, thaca, NY, 2003, Levine, D. Belman, [Link], E Groshen, and K. C. 0'Shaugnessy, The New Employment Contract: How ite Wage Structures at US. Emayers Have Changed (Kalaazo0, MI Union, 2001), Rosemary Balt, Alexander JS. CoM, and ltrey Keefe, “Employee Volce, Human Resource Practices, and Quit ates: Evidence from the elecommunicatons Indust,” Industral and Labor Relations Review 55(4 (uy 2002), pp. 573-504; Milgrom and | Roberts, Economics Organization, and Management (Englewood Cif, Ni Prenice-Hal, 1982.5. Shaw, N, Gupta, ad ,Delry, "Pay Dispersion and Workforce Performance: Moderating Etfecs of Incentives and interdependence,” Stategic Management 23 (2002), pp. 491-512 er F_ Drucker, “They're Not Employees, They'e People,” Harvard Business Review, February 2002, po. 70-77,[ inovict-tewmac: | Liner Agumese | 3. Defining tra Tememimw-it Conpenstin Eghth ——Detriing teSectre— Agamat Conic, 24 iver 72. PartOne fnemalAlgrment: Determining the Sucre contractor or temporary work supplicr (ex, Accountemps, Manpower Services). The se- curity guards, software engineers, accountants, and even entire company functions such as information technology services may be supplied by outsourcing specialists. Pay for these employees is based on the internal structure of their home employer (e., IBM or Accoun- ‘temps) rather than of the workplace at which they are currently located, ‘Another major work design change is delayering. Entire levels of work are disappear- ing. Delayering can cut unnecessary, noncontributing work. It can also add work to other jobs, enlarging them. This changes the job’s value and subsequently the job structure. De~ layering is occurring atthe top ofthe structure, where the number of firms with chief op- crating officers has decreased by 20 percent in the past decade.”” Delayering is also oc curring in operations. Through the use of selfsmanaged work teams, entire levels of supervisory jobs are removed and the work is delegated to the teams. All these changes influence the type of internal pay structures required to support them. Overall HR Policies The organization's other human resource policies also influence internal pay structures. Most organizations tie money to promotions to induce employees to apply for higher- level positions.*” However, some organizations believe that offering a grander job ttle is a sufficient inducement and litle or no pay differential is required.” Nevertheless, a the= cory to explain why people might want a bigger title without additional pay to go with it has yet to be worked out. Internal Labor Markets: Combining External and Organization Factors Internal labor markets combine both external and organizational factors. Internal labor ‘markets refer to the rules and procedures that (1) determine the pay for the different jobs within a single organization and (2) allocate employees among those different jobs."! As Raghuram G. Raan and Jue Wulf, "The Hattoning Frm: Evidence fom Panel Data on the Changing Nature of Corporate Hearchies,” working paper, Wharton, November 2002 2Pposemary Bal, Alexander S. Cov and Jetty Kee, “Employee Voce, Human Resource Practices, and (Qui Rates: Edence fom the Tecommunications Indust," Incstral and Labor Relations Review 552) (ly 2002), pp. 573-594, Casey hniowski, Kathnyn Shaw, and Jon Gran, "Working Smarter by Working Together: Connective Capitan the Workplace," werking pner, Columbia Unversity, New York, 2002, 2paul Schumann, Dennis Anbu, and Christine 8, Mahoney, "The Effects of Human Capital and Job CCharacterisies on Pay,” Journal of Human Rescurces 29@), pp. 481-503, 598. Kohn, Punished by Rewards: The Trouble with Gold Stars Incentive Plans, A's, Prase and Other ‘ries Boston: Houon Mii, 1993, Jrald Greenberg and Suzy N. Ornstein, “High Status Job Tes as Compensation for Underpayment: A Test of Equity Theory.” Journal of Applied Psychology 6312) (1983), pp. 285-297 5 Thomas A. Mahoney, “Organizational Heratchy and Position Worth,” Academy of Management Journal, December 1979, pp. 726-737; Bay Gethart and Sara Bynes, Compensation: Theory, Evidence, ‘ana Strateaic molcations (Thousand Oaks, CR: Sage, 2003)Fei Noa: Companion ath len EXHIBIT 3.5 Ilustration of an Internal Labor Market Teton Conais, 24 [inet Aga Detriing he Sct Chapter 3. Defining ema Akganent 73 Hire —» | Consultant Engineer — Promote Promote Lead Engineer TS Promore TS Promote Senior Engineer — Promote Hire —| depicted in Exhibit 3.5, in many organizations individuals are recruited only for specific entry-level jobs (an engineer would be hired right out of college: a senior engineer would have a few years’ experience) and ate later promoted or transferred to other jobs. Because the employer competes in the external market for people to fill these entry jobs, their pay ‘must be high enough to attract a pool of qualified applicants. In contrast, pay for jobs filled via transfer and promotions is buffered from extemal forces. External factors are dominant influences on pay for entry jobs, but the differences for nonentry jobs tend to reflect the organization's internal factors.” John Sutherland, “Wages n and Voluntary Quits rom an Establishment internal Labour Market," ‘Applied Economics 34 (2002), pp, 395-40; Philp Mess, “Earings equality and the Qual of Jobs, In Corporate Governance and Sustamable Prosper ets. W. Lazorick and M. O'Sullvan (New Yor: ‘Macmillan, 2001, Erica L Goshen and David | Levine, “The Re and Decine (1) of US. intemal Labor Marke,” Research Paper No. 9819, (New York Federal Reserve Bank, 1998S. Bacharach an E. Law, oltcal Algnments in Organizations” chap. 4 in Research in the Sociology of Organizations, Vol. N, les, Sam Bacharach and Steohen Mitchell (Greenwich CT: JAI Press, 1998),[ inovict-tewmac: | Liner Agumese | 3. Defining tra Tememimw-it Conpenstin Eghth ——Detriing teSectre— Agamat Ccnin 24 Kien 74 Part One Inna Algrment: Determining the Sucre Employee Acceptance: A Key Factor Employees judge the fairness of their pay through comparisons with the compensation paid others for work related in some fashion to their own.'® Accordingly. an important fac- tor influencing the internal pay structure is its acceptability to the employees involved.* Pay structures change in response to changing external pressures such as skill shor= ages. Over time, the distorted pay differences became accepted as equitable and custom- anys efforts to change them are resisted. Thus, pay structures established for organizational and economic reasons at an carlicr time may be maintained for cultural or other political reasons, It may take another economic jolt to overcome the eultual resistance. Then new norms for employee aeceptance are formed around the new structure. This “change-and- congeal” process does not yet support the continuous changes occusting in today's econ cmy. New norms for employee acceptance will probably need to include recognition that people must zt used to constant change, even in intemal pay relationships. The pay for airport security sereeners relative to other airport jobs illustrates the change and congeal process. Prior to 9/11, aitport serzeners were paid about $5.50 an hour with no benefits. Recent immigrants, Some undocumented, and relatively unskilled people were hired to sereen travelers and their luggage. After the 9/11 attacks, the Trans- portation Security Administration (TSA) took over airport security and screening. Wages are now comparable to police and fire protection jobs. Entry-level pay starts at around $20 an hour plus U.S. federal employee benefits. Employees in other jobs need to accept the changes in the security jobs—or they will beat the door asking for more pay.2? STRATEGIC CHOICES IN DESIGNING INTERNAL STRUCTURES. ‘The basic premise underlying the stratezi approach is that “ft” matters, Aligned pay struc tures support the way the work gets done, fit the organization's business strategy, and are fair to employees. Greater internal alignment —fit—is more likely to lead to success. Mis- ed structures become obstacles. They may still motivate employee behavior, but it may be undesirable behavior. Jeff Goldblum’s mathematician character may never have stolen the dinosaur egg in Jurassic Park if he had been given the pay raise he felt he deserved. 2PE_ Robert Lverasn, “The Internal Wage Sttucture,” In New Concepts in Wage Determination, 20s 6G.W. Taylor and F.C. Pierson (New York: McGraw, 1957), pp. 143-172, “chatie 0. Treyr and David L. Waceter, “Reactions to Interdependence among Pay Dispersion, Pay Relate to internal and ExtamalRefrents, and Procedural Fares: Toward a General Componsstory Erec,” working pape, Unversity of Wisconsin-Madison, May 2003; . Judge and H. . Heneman il, "Pay Setstactio,” in Compensation in Organizations: Curent Research and Practice, eds. 5. Rynes and G6. Gethart San Fandsco: loss. Bass, 2000); Robert Folger and Mary Konowsy, "Efects of Procedural and Distributive lustice on Reactions to Pay Raise Decsons," Academy of Management Journal, March 1989, pp. 115-130; Kimberly D. Ekbacn and Greg Elotson, “How th Packaging of Decision Explanations tects Perceptions of Trustworthines,” Academy of Management Journal 43())(2000), 9p. 80-88, Suzanne 5, Masterson, Kyle Lews, Bary M. Goldman, nd Mt, Susan Tayo, “Integrating lustice and Social Exchange: Te Differing Effects of Far Procedutes and Treatment on Work Relationships, ‘Acatemy of Management Sour 438) (2000), pp. 738-748; Stefanie E Naumann and Nathan Bennet, “A Case for Procedural Justice Climate: Development and Test ofa Muttiovel Model," Academy of Management Journal 43(5) 2060), pp. 88-289 25"Faeral Uniformed Police: Selected Data on Pay, Recrltment, and Retention at 13 Police Forces in the Washington, D.C. Metropoltan Area,” GAO-03-858, June 13, 2003Fei Noa: Companion Eth Teton Conais, 24 Chapter 3. Defining ema Alganent 75 But what does it mean to fit or tailor the pay structure to be internally aligned? Two strategie choices are involved: (1) how tailored to organization design and work flow to make the structure, and (2) how to distribute pay throughout the levels in the structure. Tallored versus Loosely Coupled A low-cost, customer-focused business strategy such as that followed by MeDonalA’s ot ‘Wal-Mart may be supported by a closely tailored structure, Jobs are well defined with de- tailed tasks or steps to follow. You can go into a McDonald's in Cleveland, Prague, or Shanghai and find they all are very similar. Their pay structures are, too. The customer representative and the food preparation jobs are very well defined in order to eliminate variance in how they are performed. The amount of ketchup that goes on the burger is premeasured; even the keys on the cash register are labeled with menu items rather than numbers. It is hard to make a mistake in these jobs. It is also hard to be the very best french fryer in the whole company. Differences in pay among jobs are relatively small In contrast to McDonald's, 3M’s business strategy requires constant product innovation and short produet-design-to-market eycle times. The 3M competitive environment is turbu- lent and unpredictable. 3M engineers may work on several teams developing several prod- ucts a the same time. 3M’s pay system needs to accommodate this exibilty. Hence, its pay structures are more loosely linked to the organization in order to facilitate constant change, Egalitarian versus Hierarchical EXHIBIT 3.6 Strategic Choiee: Hierarchical versus Egalitarian Pay structures can range from egalitarian at one extreme to hierarchical atthe other. Ex- hibit 3.6 clarifies the differences. Egalitarian structures have fewer levels and smaller dif- ferentials between adjacent levels and between the highest- and lowest-paid workers In Exhibit 3.7, Structure A has cight different levels, with relatively small differentials in ‘comparison to structure B, which has only three levels. Structure A is hierarchical compared to the egalitarian structure of B; the multiple levels typically include detailed descriptions of work done at each level and delineate who is responsible for what. Hierarchical structures provide a Jot more opportunities for promotion. Hierarchies send the message that the organization val- us the differences in work content, individual skills, andl contributions tothe organization Hierarchical <> Egalitarian Levels Many Fewer Differentials Lage Small Criteria Person or job Person or job Supports: Close tt Loose fit ‘Work Organization Individual performers Teams Fairness Performance Equal treatment Behaviors (Opportunities for promotion Cooperation 2fEot Iaques, “Ia Praise of Hierarchies,” Harvard Business Review, January-February 1900, pp. 32-40: Matthew [Link], "Te Performance Etfecs of ay Structures on indiiduas and Organizations, ‘Academy of Management Joural 42(1) 1999, 9p. 25-40,[ witoih-Newman: | intra! Age © Teen Campenction Eighth Osteria the Sacre Agent Campi Dt 6 Part One Insc Aligunent: Deming he Since EXHIBIT 3.7 Which Structure Has the Greatest Impact on Performance? ‘on Fairness? Structure A Structure B Layered Delayered CChiet Engineer chet Engineer Engineering ‘Manages Consulting Engineer Senior Lead Engineer coat Enakaer Lead Engineer Senior Engineer Engineer Engineer Trainee. Associate Engineer Structure B can also be characterized as delayered or compressed. Several levels of work are removed so that all employees at all levels become responsible for a broader range of tasks but also have greater freedom to determine how best to accomplish what is expected of them. An egalitarian structure sends the message that all employees are valued equally. It implies that more equal treatment will improve employee satisfaction, support cooperation, and therefore affect workers’ performance.*” Yet more egalitarian structures are not problem-free, either. For example, Ben and Jerry’s Homemade, a purveyor of premium ies eream, tried to maintain a ratio of only 7 1es-paid and lowest-paid employees. (When the company started, the spread was 5 to 1.) The relatively narrow differential reflected the company’s philosophy that the prosperity of its produetion workers and its management should be closely linked. The compressed structure also generated a great deal of favorable publicity. How- ever, it eventually became a barrier to recruiting. Ben and Jerry's was forced to abandon this policy to hire an accounting manager and a new CEO. And only when the company was acquired by Unilever, a Dutch multinational, did the press publicize the fact that the value of Ben and Jerry’s stock inereased the total compensation for founders Ben Cohen and Jerry Greenfield to mach more than the 7-to-I ratio. Sill, itis hard tobe against anything called “egalitarian.” If we instead use the word “aver= ism,” as Chinese workers do when describing the pay system under socalism’s state-owned. enterprises, where maximum differentials of 3 to 1 were mandated, some of the possible drawbacks of this approach become clear.™ Equal treatment can mean that the more know!- 27RD, Bret and, L. Thomas, “Perceed Equity, Motwaton, and Fna-Oter Arbitration in Major League Baseball,” Journal of Appfled Psychology 77 (1952), pp. 280-287; M. loom and J Michel, "The Relationships among Organizational Context, Pay Dispersion and Manager Turnover," Academy of Management Journal (1) (2002), pp. 33-42, 2®panilZ. Ding, Keith Goodal, and Malsim Warne, “The End ofthe ron Rice-Sow’ Whither Chinese Human Resource Management?” Iteratinal Joumal of Human Resource Management 11(2) (Apel 2000), pp. 217-236; Thomas L-Ping Tang, Vienne Wai-Mei Luk, and Randy K. Chiu, “Pay Diflerentils inthe People’s Republic of China: An Examination of Internal Equty and External Competitiveness,” ‘Compensation and Benefits Rewow 22(3)(May/une 2000), pp. 43-40; Li Hua Pay Policies and Determination in China," working paper, Norhwrestem University, 2003; Chao Chen, Jae Dhoi, and Shu-Cheg Chi, “Making listce Sense of Local Expatriate Compensation Disparity: Mitigation by Local Referents, Ideological Explanations, and Interpersonal Sensi in China Foreign Joint Ventures,” ‘Acar of Management Journal #318) 2002), pp. 807-817,Fei Noa: Companion Eth Teton Conais, 24 [inet Aga Detriing he Sct Chapter 3. Defi ema Algmnent 77 cedyeable employees—the stars—feel underpaid. They may quit or simply tune out and refuse to do anything that is not specifically required of them. Their change in behavior will lower ‘overall performance. Soa case can be made for both egalitarian and hierarchical structures. Keep in mind, though, that the choice is rarely either/or. Rather, the differences are a ‘matter of degree: Levels can range from many to few, differentials ean be lange or small, and the criteria can be based on the job, the person, of some combination of the two. Career Path Differentials Reexamine the differentials for engineers shown in Exhibit 3.3. They range from $11,000 21 percent differential between senior engineer and engineer) to $37,000 (30 percent dif ferential between consulting engineer and advisor engineer). These represent pay differ- ences available for promotion from one level in the structure to the next. Recall from Chapter 1 that promotion increases add into base pay, so their expected value compounds cover the employee's entire career. WHAT THE RESEARCH TELLS US. Before managers recommend a pay structure for their organizations, we hope they will not only look at organization strategy, work flow, fairness, and employee motivation but also look at the research, Both economists and psychologists have something to tell us about the effects of various structures. Equity Theory Employees judge the equity of their pay by comparing the work, qualifications, and pay for jobs similar to theirs." However, very little research addresses the question of what specific factors influence employees’ perceptions of the equity or fairness of the pay structure, as opposed to the equity oF faimess of the amount of pay:*? Consequently, eq- Lity theory could support both egalitarian and hierarchical structures. Tournament Theory Economists have focused more directly on the motivational effects of structures. Their starting point is a golf tournament where the prizes total, say, $100,000. How that {$100,000 is distributed affects the performance of all players in the tournament. Compare 1 3-prize schedule of $60,000, $30,000 and $10,000 with a ton-prize schedule of $19,000, 2%E.£ Lawler, Pay ang Organzatonal Eiactveness: A Psychological View (New York: MeGiawi, 1971); EE. Lawier, Rewarding Excelence: Pay Strategies forthe New Economy (San Francisco: Jssey ass, 2000), TA. Mahoney, Compensation and Reward Perspectives (Homewood, I: lin, 1979. “ST. judge and HG. Heneman Il, "Pay Satistacton,” in Compensation in Organizations: Curent esearch and Practice, eds. 5. Rynes and G. Gear (San Fanckco: lossey-8ss, 2000), Foard F. Jones, Vida Scape and Thomas Bergmann, “Pay Procedures—What Makes Them Fa?” Jounal of Occupational and Organizational Psychology 72 (1990), pp. 129-145; Chale O. Trevor and David. Wazeter, “Reactions to Inerdependence among Pay Dispersion, Pay Relate to Internal and External Referens, and Procedural Falmess: Toward a General Compensatory Effect” working paper, Unversity of Wiscorsn-Maaon, May 2003 41S, Shaw, N. Gupta, and |. E. Deer, “Pay Dispersion and Workforce Performance: Moderating Effects of incentives and interdependence,” Strategic Management 23 2002), pp. 431-512.[ inovict-tewmac: | Liner Agumese | 3. Defining tra Tememimw-it Conpenstin Eghth ——Detriing teSectre— Agamat Conic, 24 Kien 78 Part One Inna Algrment: Determining the Sucre $317,000, $15,000, $13,000, and so on. According to tournament theory, all players will play better in the First tournament where the prize differentials are sizable. Raising the total prize money by $100,000 in the Professional Golf Association tournament lowered each player's score, on average, by 1.1 strokes over 72 holes." And the closer the players got to the top prize, the more their scores were lowered. (Note to nongolfers: A lower score isan improvernent,) Applying these results to organization structures, the greater the differential between your salary and your boss's the harder you (and everyone else but the boss) will work. If Lockheed pays its advisor engineers $125,000, and its consultant engineers $162,000, the tournament model says that everyone (except the consultants) will work harder ifthe eon- sultants are instead paid $200,000. Rather than resenting the big bucks paid to the con- sultants, engineers at all levels in the structure will be motivated by the greater differen tial to work harder fo be a “winner.” that is, gt promoted to the next level on the way to being @ consultant engineer. Within limits, the bigger the prize for getting to the next level ofthe structure the greater the motivational impact the structure will have. Several studies support tournament theory. One reported that giving larger raises with 1 promotion increases effort and reduces absentecism.# Others find that performance im- proves with larger differentials at the top levels of the structure. The “winner-take-all” idea springs from these studies However, a study of the National Basketball Associa- tion revealed that once teams fail to wet into the playoffs, where players would have made a lot more money, team performance drops precipitously. Infact, it can be called a “race for the bottom.” Why? The poorest teams have firt-draft choice for next year’s new players. So, overnight, the reward is for worst record rather than best.” But most work is not a round of golf or a good jump shot. Virtually all the research that supports hierarchical structures and tournament theory ison situations where individ- ual performance matters most (auto racing, bowling, golf tournaments) or, at best, where the demand for cooperation among a small group of individuals is relatively low (profes- sots, stockbrokers). In contrast, team sports provide a setting where both individual play- ers’ performance and the cooperative efforts of the entire team make a difference.*7 Using eight years of data on major league baseball, one study found that teams with ezal- 0. E. Becker and M.A, Huse, “The Incentive Effects of Tournament Compensation Systems,” Adirnistative cence Quartery 37 (1992), pp. 336-350; E. Lazear and S. Rosen, “Rank-Order “Tournaments a5 Optimum Labor Contacts,” Journal of Poitca/ Economy 83 (1981), pp. 841-864; Matthow C. Bloom, “The Performance Effects of Pay Structures on ndiduas and Organizations,” ‘Academy of Management four 42(1) (199), pp. 25~40; Michael L. Boonanro, "Corporate “Tournaments,” Journal of Labor Economics 19(2) (2001), pp. 250-315 ‘PRG. Ehrenberg and M. L Bognanno, “Te incentive Etfects of Tournaments Reed: Evidence from the European PGA Tour Industrial and Labor Relations Review 43 (1990), pp. 748-88; Tor Eriksson, “Brecutve Compersation and Tournament Theory: Empincal ests on Danish Data,” Journal of Labor Economics Apel 1989, pp. 262-220. “%E,P. Latear, Personnel Economics (Camevidge, MA MIT Press, 1995) “Robert H, Frank and Pip. Cook, The Winer-Take-Al Sacew: Why the Few a the Top Get So Much ‘More Than the Rest of Us (New York: Penguin, 1996). “Beck A. Taylor and Justin G. Trogdon, “Losing to Win: Tournament Incentives inthe National Basketbat ‘Asodalion,” Jounal of Labor Ecenamics 20(1) (2002), pp. 23-41 “Matthew C. Bloom, “The Performance Effects of Pay Structures on individuals and Organizations," ‘Academy of Management Sour 42(1) (1999), pp. 25-40.Fei Noa: Companion Eth [inet Aga Tememaw-it Detriing he Scare Alguet nan, 24 Chapter 3. Defi haem Algmnent 79 itarian structures (practically identical player salaries) did better than those with hierar- chical structures (very large differentials among players). In addition to affecting team performance (games won, gate receipts, franchise value, total income), egalitarian struc tures had a sizable effect on players’ individual performance, too (batting averages, er- rors, runs batted in, cte.). A mediocre player improved more on a team with an egalitarian structure than on a team with a hierarchical structure, OF course, it may also be that the cgalitarian pay structure reflects a more flexible, supportive organization culture in which a mediocre player is given the training and support needed to improve. The egalitarian structure would be aligned with an ealitarian corporate culture. Cybercomp Salaries fr all the players on the major league baseball teams are listed at ‘ww canoe ca/BaseballlMoneyMatters/saaries players html. Pick some of your favorite teams and compare the highest- and lowest-paid players on the team. Based on the differentials, which teams do the models and research discussed inthis chapter predict will hhave the better record? Click on the link for “Standings” and check it out. Suggestion: Don’t bet your tuition on the relationship between player salary differentials on a team and the team’s performance Tournament theory does not directly address turnover. However, a study of executive leadership teams in 460 organizations concluded that executives were twice as likely to leave if the companies had large pay differentials among the leaders.* In this study, hier- archy breeds turnover. For example, Biomet CEO Dane Miller would hardly notice if his, pay envelope was switched with someone else’s on the leadership team. There is only about a 15 percent pay difference among the top five executives at Biomet. In contrast, at Louisiana Pacific, CEO Mark Suwyn’s salary and bonus totaled $1.37 million, about three times the total of other executives on his team. True to prediction, Louisiana Pacific hhad 13 changes in its five-person executive team over five years, compared to only | change on the Biomet team (a retirement). Conclusion: If executives need to operate Tike a baseball team, then an egalitarian structure is probably a beter fit Institutional Model: Copy Others ‘Some organizations ignore the question of strategy altogether. Instead, they simply copy ‘what others are doing. By extension, intemal pay structures are sometimes adopted be~ cause they have been called a “best practice.” It is still common for managers to bring back “the answers” discovered at the latest conference. Recent examples of such behav- iors include the rush to delayer, to emphasize teams, to deemphasize individual contribu tions, and to shift to a competency-based pay system, often with litle regard to whether sik, Bloom and J. Michal, “The Relationships among Organizatonal Context Pay Dispersion and ‘Managerial Tumane,” Academy of Management Journal (1) (2002), pp. 33-42, W. Jurgens, “Look Out ow,” Wal Steet Journal, Apt 1, 2000, p. 3 499, S Tolbert and LG. Zucker, "Insttutionalzation of Institution Theoy,” in; Handbook of ‘Organtaton Stutes, pp. 175-199; eds. [Link], C. Hardy, and W. Nora London: Sage, 1996), M-Barrnger and G. Mikovch, “A Theoretical Exploration ofthe Adoption and Design of Fleuble Benefit Pans: A Case of HR Innovatio,” Academy of Management Review 2312) (1998, pp. 305-224: Y. Yanadort, "Orgarizaton Variations in Stock Option Designs Insights of Organization Theory," working Paper, CARS, ithaca, NY, 2004,[ witoih-Newman: | intra! Age © Teen Campenction Eighth Osteria the Sacre Agent Campi Dt ion 80 Part One Incr Aligunent: Deming he Since EXHIBIT 3.8 Some ‘Consequences ofan Internally Aligned Structure Undertake taining Increase experience Reduce tumover Pay structure Facilitate career progression Facile performance Reduce pay-related grievances Reduce pay-elated work stoppages any of these practices make sense (fit) forthe particular organization oF its employees.°° The institutional model predicts that very few firms are “frst movers”; rather, they copy innovative practices after innovators lear whether the practices work. The copiers have little concem for best fit, opting instead for best practice Which Structure Fits Best? Exhibit 3.8 summarizes the effects attributed to internally aligned structures: + More hierarchical structures are related to greater performance when the work flow depends more on individual contributors (ex, consulting and law practices, surgical units, stockbrokers, even university researchers). + More egalitarian structures are related to yreater performance when close collaboration and sharing of knowledge are required (e.., firefighting and rescue squads, manufac turing teams, hotel customer service staffs, global software design teams). The competi- tion fostered in the “winner-take-all” tournament hierarchies appears to have negative cffects on performance when the work flow and organization design require teamwork, + Structures that are not aligned with the work flow appear to be related to greater turnover Beyond these points, much remains to be studied. There is practically no research on the optimal size of the promotional increase or its effects on behaviors, satisfaction, or perfor- mance. Nor is much known about whether smaller, more frequent promotions are better (or ‘worse) than fewer, large, less frequent promotions. Perhaps informal expectations get devel- oped at each workplace. (“You can expect to get promoted here after about three years. and a 10 percent hit usually goes with it”) In universities, promotion from assistant to associate pro- fessor tends to occur after six years, although there is no norm on promotion pay inereases. In Japanese pay structures, promotion from associate to kukaricho occurs after five years in a company. Similar norms exist in the military. Lite is known about how these rules of thumb develop and what their original logic was. But they do matte. Promotions sooner (or later) than expected, accompanied by a larger (or smaller) pay increase, send a powerful message. “Hay Levinson, “Why the Behemoths Fe: Psychological Roots of Corporate Fale,” American Paycholoast 415) 1994), pp, 428-43Fei Nos: Companion hth T inet Agee | 3. Deng tra oreo — | Detriing he Sram Agumnt Cen, 208 Chapter'3 Defi tema Aligamene 81 So what size should the pay differentials be between the adjacent engineering levels within Lockheed? To answer this question, we would need to understand how differen- tials within the career path support Lockheed’s business strategy and work flow, motivate engineers to contribute to Lockheed’s success, and are considered fair by the engineers. ‘The next several chaptors discuss how to manage these internal structures. CONSEQUENCES OF STRUCTURES Let’s tun again to that “so-what” question. Why worry about internal alignment at all? ‘Why not simply pay employees whatever it takes to get them to take a job and to show up for work every day? Why not let external market forces or what competitors are paying, determine internal wage differentials? There are several very practical reasons for paying attention to internal structures. The first is unique jobs that reflect organization idiosyncrasies. For example, the National ‘Aeronautics and Space Administration (NASA) employs a planet protection specialist ‘whose job is to see that neither Mars nor Earth (nor any other planets) ate inadvertently contaminated in the course of planetary exploration. No other employer in this world (or any otier) has a planet protection specialist on the payroll. How does NASA determine the appropriate pay for this job? A friend suggested that NASA start with whatever it pays for “plant protection” (guards rather than sprayers of aphids) anc! add “a wee bi Instead, NASA chose to compare the skillknowledge/experience/responsibilites forthe planet protection job with requirements for other NASA jobs. Its existing internal pay structure provides a basis for ariving ata rate for unique jobs.*! The second reason for payi to internal alignment is that, as we have al- ready noted, different job structures must be harmonized during acquisitions and mergers. Increasingly, the most vivid illustration is from global companies paying people who are in different extemal markets. Yet many of these organizations say a common internal structure is required to support their global strategy. ‘ompetitive Advantage ‘Why manage the intemal pay structure? An aligned structure has the potential to lead to better organization performance. If the structure does not motivate employees to help achieve the organization’s objectives, then itis a candidate for redesign. Internal pay structures imply future rewards. The size of the differentials between the entry level in the structure and the highest level may induce employees to remain with the coryanization, increase their experience and training, cooperate with co-workers, and seek seater responsibility. Chapter 2 raised the strategy question, Do you want to be difficult to imitate? We al ready noted that the number of levels and titles in a career path may be rewarding beyond "Previous editions ofthis textbook used an example of a unique job taken from Cornel Univesty's School of Veterinary Mediine. Forme students have expressed great affection forthe "Cornel cows" However, in ont of a changing environment, we are tying to move fom the agrarian to tne aquaria. "Edward Lazear, "Labor Economics and Psychology of Organization," Journal of Economic Perspectives 5 (1901), pp. 89-110; Davia Wazetr, "Determinants and Consequences of Pay Structures,” Ph. dissertation, Cornel Unversity, 1951[ inovict-tewmac: | Liner Agumese | 3. Defining tra Tememimw-it Conpenstin Eghth ——Detriing teSectre— Agamat Ccnin 24 en 82, PartOne Ina Alpine: Deming che Sucre Fairness Compliance the pay attached to the tiles. Microsoft added a “distinguished enginger” tile to its struc ture. The consulting firm MeKinsey and Company added an “associate partner.” Their tionale was that more frequent steps inthe career ladder offer employees more opportunities for rewards. These are new titles and levels that are not yet reflected in the external market. ‘The carly-20th-century U.S. labor leader George Meany is famous for his reaction to pro- posed pay innovations: “Tell me how much pay we will get, and I will tell you if | ike * Hierarchical structures evoke the same response. If | am at the top of the structure, 1 am probably persuaded that my high pay is an important signal to suppliers and cus- tomers that the company is doing well. IF am lower in the structure, Iam probably less persuaded that the company ties its pay to employee contributions—at least, not my (un- dervalued) contributions.» Several writers argue that employees" attitudes about the faimess of the pay structure af= fot their work behaviors. Writers have long agreed that departures from an acceptable ‘wage structure will occasion tumover, grievances, and diminished motivation * But that is where the agreement ends. One group arsues that if fair (ie, sizable) differentials among Jobs are not paid, individuals may harbor ill will toward the employer, resist change, change employment if possible, become depressed, and “lack that zest and enthusiasm which makes for high efficiency and personal satisfaction in work.” Others, including labor tunions, argue for only small differentials, in the belief that more egalitarian structures sup- port eam cooperation, commitment tothe organization, and improved performance. ‘As with any pay decision, the design and management of internal pay structures must comply with the regulations ofthe countries in which the organization operates. While the research on internal alignment is very informative, thee is still alot we do not know. What about the appropriate number of levels, the sizeof the differentials, and the cri- teria for advancing employees through a sructure? We believe the answers lie in under- standing the factors discussed in this chapter: the organization's strategic intent, organiza- tion design and work flow, human capital, and the external conditions, regulations, and customs it faces. We also believe that aligning the pay structure to fit the organization and the surrounding consltions is more likely to lead to competitive advantage forthe organiza~ tion and a sense of far treatment for employees. On the other hand, beliefs, experience, and common sense ofien mislead, Turns out there are no canals on Mars, and frogs don’t cause warts. So there is genoral agreement that internal pay structures probably do motivate peo- ple. But exactly what behaviors result from this motivation needs to be better understood.” "RL Heneman, Ment Pay: Linking Pay Increases to Performance Ratings (Reading, MA: Addison Nesey, 1992); H. H. Meyer, “The Fay-tor Performance Dilemma,” Organization Science 33 (1975), 9p. 39-50, “Foard F. Jones, Vida Scarpa, and Thomas Bergmann, "Pay Procedures—What Mates Them Fi? Joumsal of Occupational and Organizational Psychology 72 (1995), pp. 129-145 SE, Robert Livernas, “The Imernal Wage Structure,” in New Concepts in Wage Determination, ets GW. Taylor and F.C Pierson (New York: McGraw-il, 1957), pp. 143-172. >Pelict Jaques, "In raise of Hierarchies,” Harvard Business Revi, January-February 1990, pp. 32-46, "Richard Feynman, “Cargo Cult Scence: Some Remarks on Science, Pseudoscience, and Learing How to Not Fool Yous,” n Feynman, The Pleasure of Fring Things Out (Cambie: Perseus, 1990), pp. 205-216; Catt Sagan, The Demon Haunted Works Science as a Canc in the Dark Neve York: Balt, 1997.