Compensation of Special Groups

Milkovich−Newman: Compensation, Eighth Edition

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© The McGraw−Hill Companies, 2004

Chapter Fourteen Compensation of Special Groups Chapter Outline Who Are Special Groups? Compensation Strategy for Special Groups Supervisors Corporate Directors Executives

Scientists and Engineers in HighTechnology Industries Sales Forces Contingent Workers

Your Turn: Compensation of Special Groups

The country’s in a bind, but I’m cheerful and I’m chipper, As I slash employee wages like a fiscal Jack the Ripper. And I take away their health care and never mind their hollers. And pay myself a bonus of a couple of million dollars. Mark Russell Comedian

Mark Russell’s satirical song is a reflection of our worst fears about pay: Injustice hits the common worker first. This chapter takes a look at groups that, for reasons we will discuss, receive compensation that is anything but common. Our goal is to show the logic of compensation practices for these special groups. So far we have described compensation programs as if they were fairly uniform across all jobs in an organization: organization: Jobs are analyzed; analyzed; then job evalu evaluation ation determines determines a job’s internal internal worth; salary surveys give an indication of what other competitors pay for the job; discrepancies are reconciled; and provisions are made to recognize that variation in performance across individuals in the same job should be recognized with compensation differences. Not all jobs follow all these stages, though. Indeed, all we have to do is open a newspaper to see that some jobs and some people are singled out for special compensation treatment in an organization. Why will Bobby Holik, a fast-skating forward for the New York Rangers, make $45 million over the next five years? Why has Michael Eisner (chief executive officer, Walt Disney Company) received more than $700 million in compensation since 1996, during a

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period when Disney stock fell 22.6 perce period percent? nt?1 Is the value of these jobs determined in the same way that compensation is determined for other jobs in a company? The answer is probably no. But why? To answer this question, it is useful to work backward. What jobs get special compensation treatment in a company? Are they basically the same kinds of jobs across companies? If they are the same kinds of jobs, are there any common characteristics the jobs share that would cause companies to devise special compensation packages?

WHO ARE SPECIAL GROUPS? When we look at company practices with these questions in mind, a pattern begins to emerge. Special treatment, either in the form of add-on packages not received by other employees or in the form of compensation components entirely unique in the organization, tends to focus on a few specific groups. This chapter argues that special groups share two characteristics. First, special groups tend to be strategically important to the company. If they don’t succeed at their jobs, success for the whole organization is in jeopardy. Second, their positions tend to have built-in conflict, conflict that arises because different factions place incompatible demands on members of the group. As the first characteristic explains, the work these employees perform is central to the strategic success of the company. As an example, consider the contrast in compensation treatment for engineers in two different organizations. One is a high-technology firm with a strong research and development component. The other organization employs a few engineers, but their role is not central to the mission of the organization. A survey of this type of difference in employee composition and organizational strategy found that research and development organizations with heavy concentrations of engineers had evolved unique compensation systems that were responsive to the special needs of the engineering contingent. Organizations with a different focus and with fewer engineers merged this group’s compensation with t he standard package offered to other employees. Exhibit 14.1 describes the nature of the conflicts faced by such special groups as su pervisors, top management, boards of directors, scientists and engineers, sales personnel, and contingent workers. When both of these characteristics are present, we tend to find distinctive compensation practices adopted to meet the needs of these special groups.

COMPENSATION STRATEGY FOR SPECIAL GROUPS Supervisors Remember, supervisors are caught between the demands of upper management in terms of production and the needs of employees in terms of rewards, reinforcements and general counseling.2 The major challenge in compensating supervisors centers on equity. Some incentive must be provided to entice nonexempt employees to accept the challenges of being a supervisor. For many years, the strategy was to treat supervisors like 1R.

Blumenthal, “Disney Shareholders Reject Pay Review for Top Brass,” Barron’s, March 24, 2003, p. 10. Frost, “Handling the Pain of Others: The Hidden Role of Supervisors,” Canadian HR Reporter, April 7, 2003, pp. 7–8. 2P.


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Compensation of Special Groups 461

EXHIBIT 14.1 Conflicts Faced by Special Groups Special Group

Type of Conflict Faced

Supervisors

Caught between upper management and employees. Must balance need to achieve organization’s objectives with importance of helping employees satisfy personal needs. If unsuccessful, either corporate profit or employee morale suffers. Stockholders want healthy return on investment. Government wants compliance with laws. Executives must decide between strategies that maximize short-run gains at expense of long run versus directions that focus on long run. Face possibility that disgruntled stockholders may sue over corporate strategies that don’t “pan out.” May be torn between goals, objectives, and ethical standards of their profession (e.g., should an engineer leak information about a product flaw, even though that information may hurt corporate profits) and demands of an employer concerned more with the profit motive. Often go for extended periods in the field with little supervision. Challenge is to stay motivated and continue making sales calls even in the face of limited contact or scrutiny from manager. Play an important “safety valve” role for companies. When demand is high, more are hired; when demand drops, they are the first workers downsized. Employment status is highly insecure and challenge is to find low-cost ways to motivate.

Top management

Boards of directors Professional employees

Sales staff

Contingent workers

lower-level managers. But in doing so, the existing job evaluation system sometimes left these supervisors making less money than the top-paid employees they supervised. As you might imagine, this created little incentive to take on the extra work involved. More recently organizations have devised several strategies to attract workers into supervisory jobs. The most popular method is to key the base salary of supervisors to some amount exceeding the top-paid subordinate in the unit (5 to 30 percent represents the typical size of the differential). Another method for maintaining equitable differentials is simply to pay supervisors for scheduled overtime. Companies that do pay overtime are about evenly split between paying straight time and paying time and one half for overtime hours. The biggest trend in supervisory compensation centers on increased use of variable pay. Slightly more than half of all companies now have a variable pay component for su pervisors, up from 16 percent in prior years.3

Corporate Directors A typical board of directors comprises 10 outside (the company) and 3 inside directors, each having a term averaging three years. Historically, directors frequently were given the role of “rubber stamping” decisions made by top management. Such boards were stacked with people affiliated in some way with the organization (e.g., retired corporate officers, suppliers, attorneys). Modern corporate boards have changed considerably. Ap proximately two-thirds of boards now include more outside directors than inside directors 3IOMA,

Pay for Performance Report, May 2000, p. 6.






(e.g., CEO, corporate officers), and this move to more outside directors comes with a price—higher compensation. Almost 75 percent of the companies planning on increasing board pay this year will do so because of competition for talented outside directors.4 Outside members now include unaffiliated business executives, representatives from important segments of society, and major shareholders. For example, Walter Mondale, vice president under Jimmy Carter, served on six boards of directors and was compensated $523,000 for his efforts.5 The 200 largest industrial and service companies, plus the top 100 dot-coms, averaged $138,747 in total compensation of board members. Despite the intention to increase pay, total compensation still declined somewhat in year-to-year comparisons. The uncertainty in the stock market has led to increased base pay, less stock-based compensation, and an overall decline (exercised options in wildly increasing stock markets led to nice incentive-based packages—that has declined recently). Depending on the industry, recent figures suggest that total director compensation ranges from $40,000 to the low $50,000s.6 In addition to cash compensation, there is an increasing emphasis on director rewards that attempt to link to corporate performance. Shareholders are holding directors accountable for firm performance. Reflecting this trend of linking pay to performance, 61 percent of the compensation for directors in large companies is some form of stock. 7 This trend is increasing despite the lack of evidence that giving board members more shares of stock results in better firm performance.8 The rest of the compensation is divided among annual retainers, committee chair fees, and board meeting fees. For example, each director receives almost $1,500 for each board meeting attended.9

Executives How would you like to make $15.7 million per year? That is the average for chief executive officers (CEOs) in the 100 largest U.S. companies.10 How does someone earn a com pensation package like that? Well, consider Dennis Kozlowski. He made $82 million last year, enough to be near the top of the list of highly paid executives. At the same time, stock in his company slid 71 percent. And, oh, by the way, he has been accused of wholesale looting of his company.11 If you and I had wages that rose as fast as those of CEOs, earnings of $25,000 in 1994 would be $138,000 today. 12 Is it any wonder that lofty executive pay packages are now the subject of public outrage. Exhibit 14.2 gives a brief history of how executive compensation climbed to such heights. Pay attention to the way the granting of stock options has gradually played a bigger role in executive compensation.

4was.hewitt.com/hewitt/resource/newsroom/pressrel/2003/02-12-03.htm, visited

June 19, 2003.

5G.

Strauss, “From Public Servant to Private Payday,” USA Today, April 17, 2000, p. B1. “Conference Board Reports Outside Director Pay Drops,” Report on Salary Surveys, February 2002, p. 3. 7”2000 Director Compensation,” Pension Benefits, November 2001, p. 12. 6IOMA,

8C.

Daily, “The Problem with Equity Compensation,” Journal of Business Strategy 23(4) (2002), p. 28. Pension Benefits, November 2001, p. 12.

9”2000 Director Compensation,” 10J.

Useem, “Have They No Shame?” Fortune, April 28, 2003, pp. 56–64.

11Ibid. 12”Executive

Pay,” Business Week, April 19, 1999, p. 78.





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EXHIBIT 14.2 Brief History of Executive Compensation The Year

The Key Event

1974 1979 1983

Michael Bergerac cracks the $1 million mark when recruited to Revlon. Chrysler’s Lee Iacocca takes $1 million plus 400,000 option shares. William Bendix of Bendix becomes the first executive to collect a huge golden parachute (contract clause for payment in a ta keover leading to termination) of $3.9 million over five years. Congress tries to limit excessive golden parachutes but gives rise to unintended consequences—the rules actually lead to larger amounts. New law gives favorable tax treatment to stock option awards. Sizes increase. Lee Iacocca receives first megagrant of stock options: 820,000 option shares worth 15.3 times his salary and bonus that year. Junk bond expert Michael Milkin explodes through the $5 million mark in salary and bonus. Leon Hirsch of US Surgical gets even larger megastock option award, worth 126 times his salary and bonus. Securities and Exchange Commission rules CEO salaries must be disclosed more often in proxy statements. Easier availability of peer compensation data serves to drive up the standard. Michael Eisner of Walt Disney exercises low-cost stock options for pretax profit of $126 million. New tax law sets upper limit on tax-deductible executive compensation at $1 million but has unintended effect of raising bar to that level. Charles Wang, Computer Associates Intl. executive, cracks two-thirds of billion-dollar mark. Alfred Lerner, MBNA executive, is top-paid CEO, with $195 million, a drop from prior years, leading to speculation that furor over CEO pay is finally having an impact.

1984 1986 1987 1987 1987 1992 1992 1993 2000 2003

Source: Business Week, April 17, 2000, p. 100, April 23, 2003; and Wall Street Journal, April 11, 1996, p. R4.

EXHIBIT 14.3 Top Five Executives in Total Compensation (in millions)

1. Alfred Lerner, MBNA 2. Jeffrey Barbakow, Tenet Healthcare 3. Millard Drexler, Gap 4. Dennis Kozlowski, Tyco International 5. Irwin Jacobs, Qualcomm

2002 Salary and Bonus

Long-Term Compensation

Total Pay

$9.0 $5.5 $2.5 $4.0 $1.8

$185.9 $111.1 $88.5 $67.0 $61.6

$194.9 $116.6 $91.0 $71.0 $63.3

Source: L. Lavelle, F. Jespersen, S. Ante and J. Kerstetter, “Executive Pay,” Business Week, April 21, 2003.

Exhibit 14.3 shows the total compensation for the top five executives in the United States. Notice how most of these five, as is true for many highly paid executives, reap the greatest rewards from long-term incentives, usually by exercising stock options. Many critics argue that this level of compensation for executives is excessive. 13 And this phenomenon exists only in the United States. Wages in the European Union, for example, are much lower. Wages plus incentives for French CEOs, the highest-paid executives, average 13M.

Langley, “Big Companies Get Low Marks for Lavish Executive Pay,” Wall Street Journal, June 9, 2003, p. C1; Graef S. Crystal, In Search of Excess (New York: Norton, 1991).






about $2 million in a sample of the 300 largest European companies. U.K. salaries for CEOs are about 16 percent behind this, and other European executives fall even further behind.14 Cybercomp For a union view of CEO wages, visit www.aflcio.org/paywatch/. This site is maintained by the AFL-CIO and is designed to monitor executive compensation. The Union view is that CEOs are overpaid and that monitoring is the first step to curbing excess.

Are the critics right? One way to answer the question is to look at the different ways executive compensation is determined and ask, “Does this seem reasonable?”

Possible Explanations for CEO Compensation One approach to explaining why executives receive such large sums of money involves social comparisons.15 In this view, executive salaries bear a consistent relative relationship to compensation of lower-level employees. When salaries of lower-level employees rise in response to market forces, top executive salaries also rise to maintain the same relative relationship. In general, managers who are in the second level of a company earn about two-thirds of a CEO’s salary, while the next level down earns slightly more than half of a CEO’s salary. 16 Much of the criticism of this theory, and an important source of criticism about executive compensation in general, is the gradual increase in the spread between executives’ compensation and the average salaries of the people they employ. In 1980, CEOs received about 42 times the average pay of lower-level workers. Now top executives are paid 475 times the pay of the average factory worker. 17 As a point of reference, the corresponding differential in Japan is under 20. 18 Both these pieces of information suggest that a social comparison explanation is not sufficient to explain why executive wages are as high as they are. A second approach to understanding executive compensation focuses less on the difference in wages between executive and other jobs and more on explaining the level of executive wages.19 The premise in this economic approach is that the worth of CEOs, or their subordinates, should correspond closely to some measure of company success, such as profitability or sales. Intuitively, this explanation makes sense. There is also empirical support. Numerous studies over the past 30 years have demonstrated that executive pay

14P.

Betts, “France Has the Fattest Cats,” Financial Times, June 23, 2003. Henderson and J. Fredrickson, “Top Management Team Coordination Needs and the CEO Pay Gap: A Competitive Test of Economic and Behavioral Views,” Academy of Management Journal 44(1) (2001), pp. 96–107; A. Simon, Administrative Behavior, 2d ed. (New York: Macmillan, 1957). 15A.

16Conference Board, 17”Executive 18R.

Top Executive Compensation: (New York: 1996). Pay,” Business Week, April 17, 2000, p. 110.

Blumenthal, “The Pay Gap between Workers and Chiefs Looks like a Chasm,” Barron’s, September 4, 2000, p. 10. This comparison needs to be interpreted with some caution. One counterargument (the Hay Group, Compflash, April 1992, p. 3) notes that American companies are generally much larger than their foreign counterparts. When compared to like-size companies in other countries, the U.S. multiple is comparable to the international average. 19A. Henderson and J. Fredrickson, “Top Management Team Coordination Needs and the CEO Pay Gap: A Competitive Test of Economic and Behavioral Views,” Academy of Management Journal 44(1) (2001), pp. 96–107.





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bears some relationship to company success.20 A recent article analyzing the results from over 100 executive pay studies found empirical evidence that firm size (sales or number of employees) is by far the best predictor of CEO compensation. Size variables are nine times better at explaining executive compensation than are performance measures. How big the firm is explains what the boss gets paid better than does how well he performs!21 Some evidence contradicts this, though. Two studies combined both social comparison and economic explanations to try to better understand CEO salaries. 22 Both of these ex planations turned out to be significant. Size and profitability affected level of compensation, but so did social comparisons. In one study, the social comparison was between wages of CEOs and those of the board of directors. It seems that CEO salaries rose, on average, 51 percent for every $100,000 more that was earned by directors on the board. 23 Recognizing this, CEOs sometimes lobby to get a board loaded with directors who are highly paid in their primary jobs. A third view of CEO salaries, called agency theory, incorporates the political motivations that are an inevitable part of the corporate world. Sometimes, this argument runs, CEOs make decisions that aren’t in the economic best interest of the firm and its shareholders. One variant on this view suggests that the normal behavior of a CEO is self-protective—CEOs will make decisions to solidify their positions and to maximize the rewards they personally receive.24 As evidence of this self-motivated behavior, consider the following description of how executives ensure themselves high compensation.25 The description comes from the experience of a well-known executive compensation consultant, now turned critic, who specialized for years in the design of executive compensation packages: 1. If the CEO is truly underpaid: A compensation consultant is hired to survey actual competitors of the company. The consultant reports to the board of directors that the CEO is truly underpaid. Salary is increased to a competitive or higher level. 2. If the CEO is not underpaid and the company is doing well: A compensation consultant is hired. Specific companies are recommended to the consultant as appropriate for surveying. The companies tend to be selected because they are on the top end in terms of executive compensation. The consultant reports back to the board that its CEO ap pears to be underpaid. Salary is increased.

20Ibid.;

Marc J. Wallace, “Type of Control, Industrial Concentration, and Executive Pay,” Academy of Management Proceedings (1977), pp. 284–288; W. Lewellan and B. Huntsman, “Managerial Pay and Corporate Performance,” American Economic Review 60 (1977), pp. 710–720. 21H. L. Tosi, S. Werner, J. Katz, and L. Gomez-Mejia, “A Meta Analysis of CEO Pay Studies,” Journal of Management 26(2) (2000), pp. 301–339. 22A. Henderson and J. Fredrickson, “Top Management Team Coordination Needs and the CEO Pay Gap: A Competitive Test of Economic and Behavioral Views,” Academy of Management Journal 44(1) (2001), pp. 96–107; Charles O’Reilly, Brian Main, and Graef Crystal, “CEO Compensation as Tournament and Social Comparison: A Tale of Two Theories,” Administrative Science Quarterly 33 (1988), pp. 257–274. 23Charles

O’Reilly, Brian Main, and Graef Crystal, “CEO Compensation as Tournament and Social Comparison: A Tale of Two Theories,” Administrative Science Quarterly 33 (1988), pp. 257–274. 24Kathryn M. Eisenhardt, “Agency Theory: An Assessment and Review,” Academy of Management Review 14 (1989), pp. 57–74. 25Crystal, In Search of Excess.






3. If the CEO is not underpaid and the company is doing poorly: A compensation consultant is hired. The CEO laments with the consultant that wages are so low for top management that there is a fear that good people will start leaving the company and going to competitors. Of course, no one ever asks why the company is underperforming if it has such a good management team. Anyway, the result is that the consultant recommends a wage increase to avoid future turnover. In each of these scenarios CEO wages rise. Is it any surprise that executive compensation is under close scrutiny by an outraged public and, more importantly, angry stockholders.26 Agency theory argues that executive compensation should be designed to ensure that executives have the best interests of stockholders in mind when they make decisions. The outcome has been to use some form of long-term incentive plan, most commonly stock options. A Wall Street Journal /Mercer survey of 500 firms found the use of long-term incentives rising for CEOs, from 62 percent of the package in 1998 to 68 percent in 2002. 27 In the sim plest form, an executive is given the option to purchase shares of the company stock at some future date for an amount equal to the fair market price at the time the option is granted. There is a built-in incentive for an executive to increase the value of the firm. Stock prices rise. The executive exercises the option to buy the stock at the agreed-upon price. Because the stock price has risen in the interim, the executive profits from the stock sale. Although this sounds like an effective tool for motivating executives, there are still many critics.28 The major complaint is that stock options don’t have a downside risk. If stock prices rise, the stock options are exercised. If stocks don’t improve, or even decline, as was the case for much of the past four years, the executive suffers no out-of-pocket losses. Some argue that executive compensation should move more toward requiring that executives own stock, rather than just have options to buy it.29 With the threat of possible financial loss and the hope of possible substantial gains, motivation may be higher. Others advocate linking stock options to executive performance. For example, if an executive doesn’t lead his or her company to outperform other companies in the same industry, no stock options are granted. 30 Finally, there is growing recognition that the linkage between performance and pay is much more complex for executives than was previously thought. Current work focuses on firm risk, stock ownership versus stock options, and type of industry as possible additional factors explaining executive pay.31 26M.

Langley, “Big Companies Get Low Marks for Lavish Executive Pay,” Wall Street Journal, June 9, 2003, p. C1. 27IOMA, “A New Look at Long Term Incentive Plans for Execs,” Pay for Performance Report, June 2003, pp. 1, 11. 28Nancy

C. Pratt, “CEOs Reap Unprecedented Riches While Employees’ Pay Stagnates,” Compensation and Benefits Review, September/October 1996, p. 20. 29Ira T. Kay, “Beyond Stock Options: Emerging Practices in Executive Incentive Programs,” Compensation and Benefits Review 23(6) (1991), pp. 18–29. 30IOMA,

“Here’s the Latest Thinking on How Organizations Can Solve the CEO Pay Problem,” Pay for Performance Report, April 2003, pp. 1, 13. 31J. Miller, R. Wiseman, and L. Gomez-Mejia, “The Fit between CEO Compensation Design and Firm Risk,” Academy of Management Journal 45(4) (2002) pp. 745–756; W. G. Sanders, “Behavioral Responses of CEOs to Stock Ownership and Stock Option Pay,” Academy of Management Journal, 44(3) (2001), pp. 477–492; D. Balkin, G. Markman, and L. Gomez-Mejia, “Is CEO Pay in High-Technology Firms Related to Innovation? Academy of Management Journal 43(6) (2000), pp. 1118–1129.





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The second trend in response to complaints about excessive executive compensation is increasing government regulation. In 1992 the Securities and Exchange Commission entered the controversy.32 Stockholders are now permitted to propose and vote on limits to executive compensation. The 1993 Revenue Reconciliation Act limited employer deductions for executive compensation to $1 million and capped the amount of executive com pensat ion used in computing contri butions to and benefi ts from quali fied retirement plans. Ironically, this very law may be contributing to the growth of executive compensation. The $1 million mark now serves as a new standard: Many executives who had been making less than $1 million are finding their pay quickly rising to this amount.

Components of an Executive Compensation Package There are five basic elements of most executive compensation packages: (1) base salary, (2) short-term (annual) incentives or bonuses, (3) long-term incentives and capital appreciation plans, (4) employee benefits, and (5) perquisites.33 Because of the changing nature of tax legislation, each of these at one time or another has received considerable attention in designing executive compensation packages. Exhibit 14.4 traces the trend in these components over time. One obvious trend is apparent from these data. Companies are placing more and more emphasis on incentives at the expense of base salary. Such a change in emphasis signals the growing importance attached to making decisions that ensure profitability and survival of a company. Base Salary Although formalized job evaluation still plays an occasional role in determining executive base pay, other sources are much more important. Particularly important is the opinion of a compensation committee, composed usually of the company’s board of directors or a subset of the board.34 Frequently the compensation committee will

EXHIBIT 14.4 Breakdown of Executive Compensation Components Compensation Component Base salary Benefits Perks Short-term incentives Long-term incentives

1970s 60% * * 25 15

1980s 40% 15 5 20 20

1990s 33% * * 27 40

Today 16% * * 16 68

*Unreported.

Sources: IOMA, Pay for Performance Report, May 1998, p. 11, and June 2003, p. 12; various issues of the Wall Street Journal; Data from Towers, Perrin, Wyatt Co.; M. Bishko, “Compensating Your Overseas Executive, Part 1: Strategies for the 1990s,” Compensation and Benefits Review, May–June 1990, pp. 22–30.

32Michelle 33B. 34C.

Osborn, “SEC: Executive Pay Is an Issue for Shareholders,” USA Today, 1994, p. B1. Ellig, The Complete Guide to Executive Compensation (New York: McGraw-Hill, 2002).

Daly, J. Johnson, A. Ellstrand, and D. Dalton, “Compensation Committee Composition as a Determinant of CEO Compensation,” Academy of Management Journal 41(2) (1998), pp. 209–220; H. Barkema and L. Gomez-Mejia, “Managerial Compensation and Firm Performance: A General Research Framework,” Academy of Management Journal 41(2) (1998), pp. 135–148.






take over some of the data analysis tasks previously performed by the chief personnel officer, even going so far as to analyze salary survey data and performance records for executives of comparably-sized firms. 35 One empirical study suggests the most common ap proach (60 percent of the cases) of executive compensation committees is to identify major competitors and set the CEO’s compensation at a level between the best and worst of these comparison groups. 36 Bonuses Annual bonuses often play a major role in executive compensation and are primarily designed to motivate better performance. Most striking is the rapid rise in popularity of this type of compensation. Only 20 years ago just 36 percent of companies gave annual bonuses. Today bonuses are given to 90 percent of executives. Long-term Incentive and Capital Appreciation Plans Long-term incentives now account for over one-half of total executive compensation, up from 28 percent a decade ago.37 By far the most common long-term incentive remains the executive stock option. A stock option is the right (not obligation) to purchase a stated quantity of stock at a stipulated price (strike price) over a given period of time (exercise period) following certain eligibility (vesting) requirements.38 Because many of the highest-reported executive pay packages can be traced to stock options, critics have focused on their use and abuse. One clear complaint is that stock options don’t pay for performance of the executive. In a stock market that is rising on all fronts, executives can exercise options at much higher prices than the initial grant price—and the payouts are more likely attributed to general market increases than to any specific action by the executive. Efforts to counter such undeserved rewards are linked to the rise of other types of long-term incentives, some of which require that the executive “beat the market” or hit certain performance targets specifically linked to firm performance. For example, Citicorp CEO John Reed received 300,000 stock options at about $120 each. For those options to vest, Citicorp stock must reach $200 by the end of the year, an unlikely outcome given that the stock price is currently less than half that price. 39 Exhibit 14.5 identifies other types of long-term incentives and describes their main features. Clearly, in today’s more turbulent stock market, stock options are not the “mother lode” they were in the 1990s. Options granted at one price quickly become poor motivational tools when the stock price drops far below that figure. Many companies now scramble to grant new options at lower prices, reflecting better the realities of a declining market. Executive Benefits Since many benefits are tied to income level (e.g., life insurance, disability insurance, pension plans), executives typically receive higher benefits than most other exempt employees. Beyond the typical benefits outlined in Chapter 13, however, many executives also receive additional life insurance, exclusions from deductibles for health-related costs, and supplementary pension income exceeding the maximum limits permissible under ERISA guidelines for qualified (eligible for tax deductions) pension plans.

35B.

Ellig, The Complete Guide to Executive Compensation (New York: McGraw-Hill, 2002). J. Miller, “CEO Salary Increases May Be Rational after All: Referents and Contracts in CEO Pay,” Academy of Management Journal 38(5) (1995), pp. 1361–1385. 37IOMA Pay for Performance Report, June 2003, p.12, and May 1998, p. 11. 36Daniel

38B.

Ellig, The Complete Guide to Executive Compensation (New York: McGraw-Hill, 2002). Pay for Performance Report, January 1999, p. 2.

39IOMA





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EXHIBIT 14.5 Long-Term Incentives for Executives Type

Description

Comments

Incentive stock options

Purchase of stock at a stipulated price, conforming with Internal Revenue Code (Section 422A).

No taxes at grant. Company may not deduct as expense.

Nonqualified stock options

Purchase of stock at a stipulated price, not conforming with Internal Revenue Code.

Excess over fair market value taxed as ordinary income. Company may deduct.

Phantom stock plans

Cash or stock award determined by increase in stock price at a fixed future date.

Taxed as ordinary income. Does not require executive financing.

Stock appreciation rights

Cash or stock award determined by increase in stock price during any time chosen (by the executive) in the option period.


Restricted stock plans

Grant of stock at a reduced price with the condition that it may not be sold before a specified date. Cash or stock award earned through achieving specific goals.

Excess over fair market value taxed as ordinary income.

Performance share/ unit plans


Source: B. Ellig, The Complete Guide to Executive Compensation (New York: McGraw-Hill, 2002).

Of course, various sections of ERISA and the tax code restrict employers ability to provide benefits for executives that are too far above those of other workers. The assorted clauses require that a particular benefit plan (1) cover a broad cross-section of employees (generally 80 percent), (2) provide definitely determinable benefits, and (3) meet specific vesting (see Chapter 13) and nondiscrimination requirements. The nondiscrimination requirement specifies that the average value of benefits for low-paid employees must be at least 75 percent of the average value of those for highly paid employees.40 Executive Perquisites Perquisites, or “perks,” probably have the same genesis as the ex pression “rank has its privileges.” Indeed, life at the top has its rewards, designed to satisfy several types of executive needs. One type of perk can be classified as internal, providing a little something extra while the executive is inside the company: a luxury office, an executive dining room, special parking. A second category comprises perks that are also com pany-related but are designed for business conducted externally: company-paid membership in clubs/associations and payment of hotel, resort, airplane, and auto expenses. The final category of perquisites should be totally isolated from the first two because of its different tax status. This category, called personal perks, includes such things as lowcost loans, personal and legal counseling, free home repairs and improvements, personal

40Dennis

Blair and Mark Kimble, “Walking through the Discrimination Testing Wage for Welfare Plans,” Benefits Quarterly 3(2) (1987), pp. 18–26.






use of company property, and expenses for vacation homes. 41 Since 1978, various tax and regulatory agency rulings have slowly been requiring companies to place a value on perks.42 If this trend continues, the taxable income of executives with creative perk packages may increase considerably. Examples of i nteresting perks are the following: • The most famous perks profile in recent years belongs to the former CEO of GE, Jack Welch. Papers filed in his divorce case showed GE paying for an apartment for him on the Upper West Side of Manhattan, as well as all food, wine, laundry, and toiletry costs. Some of his recreational perks included floor-level seats at New York Knicks games, courtside seats at the U.S. Open, and satellite TV at his four homes. Mind you, this is all above and beyond compensation regularly reported to exceed $100 million.43 • W. J. Sanders, chairman of Advanced Micro Devices, gets a security guard who dou bles as the chauffeur for his company-provided Mercedes Benz. Total cost of these since 1998? About $534,000. • World Wrestling Federation chairman Vince McMahon gets $50,000 per year to cover cleaning costs.44 Exhibit 14.6 illustrates different types of perks and the percentage of companies that offer them.

Scientists and Engineers in High-Technology Industries Scientists and engineers are classified as professionals. According to the Fair Labor Standards Act, this category includes any person who has received special training of a scientific or intellectual nature and whose job does not entail more than a 20 percent time allocation for lower-level duties. The compensation of scientists and engineers focuses on rewarding them for their special scientific or intellectual training. Here lies one of the special compensation problems that scientists and engineers face. Consider the freshly minted electrical engineer who graduates with all the latest knowledge in the field. For the first few years after graduation this knowledge is a valuable resource on engineering projects where new applications of the latest theories are a primary objective. Gradually, though, this engineer’s knowledge starts to become obsolete, and team leaders begin to look to newer graduates for fresh ideas. If you track the salaries of engineers and scientists, you will see a close resemblance between pay increases and knowledge obsolescence. Early years bring larger-than-average increases (relative to employees in other occupations). After 10 years increases drop below average, and they become downright puny in 15 to 20 years. Partly because salary plateaus arise, many scientists and engineers make career changes such as moving into management or temporarily leaving business to update their technical knowledge. In recent years some firms have tried to deal with the plateau effect and also accommodate the different career moti vations of mature scientists and engineers. 41Michael

F. Klein, “Executive Perquisites,” Compensation Review 12 (Fourth Quarter 1979), pp. 46–50. L. VanKirk and L. S. Schenger, “Executive Compensation: The Trend Is Back to Cash,” Financial Executive, May 1978, pp. 83–91. 43M. Burger, “Executive Perks: How Much Is Enough?” Potentials, October 2002, p. 25. 42R.

44G.

Strauss, “CEOs Rake in Big Perks on Top of Big Bucks,” USA Today, May 1, 2001, pp. 1–2B.





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EXHIBIT 14.6 Popular Perks Offered to Executives Source: Hewitt Associates, 1990.

Perk Physical exam Company car Financial counseling Company plane Income tax preparation First-class air travel Country club membership Luncheon club membership Estate planning Personal liability insurance Spouse travel Chauffeur service Reserved parking Executive dining room Home security system Car phone Financial seminars Loans at low or no interest Legal counseling


Companies Offering Perk 91% 68% 64% 63% 63% 62% 55% 55% 52% 50% 47% 40% 32% 30% 25% 22% 11% 9% 6%

The result has been the creation of dual-career tracks. Exhibit 14.7 shows a typical dualcareer ladder. Notice that dual ladders provide exactly that: two different ways of progressing in an organization, each reflecting different types of contributions to the organization’s mission. The managerial ladder ascends through increasing responsibility for supervision or direction of people. The professional track ascends through increasing contributions of a professional nature that do not mainly entail the supervision of employees. Scientists and engineers have the opportunity at some stage in their careers to consider a management track or continue along the scientific track. Not only do dual tracks offer greater advancement opportunities for scientists and engineers, but maximum base pay in the technical track can approximate that of upper-management positions. A second problem in designing the compensation package of scientists and engineers centers on the question of equity. The very nature of technical knowledge and its dissemination requires the relatively close association of these employees across organizations. In fact, scientists and engineers tend to compare themselves for equity purposes with graduates who entered the labor market when they did. Partially because of this and partially because of the volatile nature of both jobs and salaries in these occupations, organizations rely very heavily on external market data in pricing scientists’ and engineers’ base pay.45 This has resulted in the use of maturity curves.

45Jo

C. Kail, “Compensating Scientists and Engineers,” in New Perspectives on Compensation, ed. David B. Balkin and Luis R. Gomez-Mejia (Englewood Cliffs, NJ: Prentice-Hall, 1987), pp. 247–281.






EXHIBIT 14.7 IBM Dual Ladders

Executives

IBM fellow

Functional management

Senior technical staff member

Senior

Senior

Development

Advisory

Project

Staff

MANAGEMENT LADDER

TECHNICAL LADDER Senior associate Associate

Engineers, programmers, scientists

Maturity curves reflect the relationship between scientist/engineer compensation and years of experience in the labor market. Generally, surveying organizations ask for information about salaries as a function of years since the incumbent(s) last received a degree. This is intended to measure the half-life of technical obsolescence. In fact, a plot of this data, with appropriate smoothing to eliminate aberrations, typically shows curves that are steep for the first 5 to 7 years and then rise more gradually as technical obsolescence erodes the value of jobs. Exhibit 14.8 illustrates such a graph with somewhat greater so-





Chapter 14

EXHIBIT 14.8 Maturity Curve: Years since Last Degree Relative to Salary

$6,100 5,900 5,800 5,700 5,600 5,500 5,400 5,300 5,200 5,100 5,000 4,900 4,800 4,700 4,600 4,500 y r a l 4,400 a s y 4,300 l h t 4,200 n o 4,100 M 4,000 3,900 3,800 3,700 3,600 3,500 3,400 3,300 3,200 3,100 3,000 2,900 2,800 2,700 2,600


High performers (90th percentile)

Average performers (50th percentile)

Poor performers (bottom 10%)

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 Years since last degree

phistication built into it, in that different graphs are constructed for different levels of performance. To construct such graphs, the surveying organization must also ask for data broken down by broad performance levels. Notice in the illustration that the high performers begin with somewhat higher salaries and the differential continues to broaden over the first few years.






Scientists and engineers also receive compensation beyond base pay. In general, hightechnology firms place a great emphasis on the use of performance-based incentives. 46 Common forms of incentives include profit sharing and stock ownership. Other incentives link payment of specific cash amounts to completion of specific projects on or before agreed-upon deadlines. Posthiring bonuses are also paid for such achievements as patents, publications, elections to professional societies, and attainment of professional licenses. Finally, organizations have devoted considerable creative energy to development of perks that satisfy the unique needs of scientists and engineers. These perks include flexi ble work schedules, large offices, campuslike environments, and lavish athletic facilities. The strategic importance of these groups dictates that both mind and body be kept active.

Sales Forces The sales staff spans the all-important boundary between the organization and consumers of the organization’s goods or services. Besides the sales function, or even as part of selling, the sales staff must be sensitive to changing consumer tastes and provide rapid feed back to appropriate departments. Indeed, there is a growing trend toward linking sales compensation to customer satisfaction measures, with about one-third of all companies reporting use of such quality-based measures. 47 The role of interacting in the field with customers requires individuals with high initiative who can work under low supervision for extended periods of time. The standard compensation system is not designed for this type of job. As you might expect, there is much more reliance on incentive payments tied to individual performance. Thus, even when salespeople are in the field—and relatively unsupervised—there is always a motivation to perform. Exhibit 14.9 shows that sales em ployees at every organization level have some component of pay (usually a large one) that is incentive-based. For top-level sales representatives the incentive-based pay can be over 40 percent of total compensation.

EXHIBIT 14.9 Sales Compensation Components Average Salary for Sales Employees Annual Revenue of Company Executive Top-level sales representative Midlevel sales representative Low-level sales representative Average of all representatives

Base Salary $87,178 78,483 49,144 37,698 54,452

Bonus plus Commision $35,721 60,976 28,035 14,294 25,571

Total Compensation $122,899 139,459 77,179 51,992 80,023

Source: C. Galea, “2002 Salary Survey,” Sales and Marketing Management, May 1, 2003.

46George

T. Milkovich, “Compensation Systems in High Technology Companies,” in New Perspectives on Compensation, ed. Balkin & Gomez-Mejia, pp. 269–277. 47“Sales Compensation Is Increasingly Tied to Quality,” Compflash, July 1995, p. 1.





Chapter 14


Designing a Sales Compensation Plan Seven major factors influence the design of sales compensation packages: (1) the nature of people who enter the sales profession, (2) organizational strategy, (3) market maturity, (4) competitor practices, (5) size of company, (6) economic environment, and (7) product to be sold. People Who Enter the Sales Profession Popular stereotypes of salespeople characterize them as being heavily motivated by financial compensation. One study supports this perception, with salespeople ranking pay significantly higher than five other forms of reward. In the study, 78 percent of the salespeople ranked money as the number-one motivator, with recognition and appreciation being ranked as the number-two motivator. 48 Promotional opportunities, sense of accomplishment, personal growth, and job security were all less highly regarded. These values almost dictate that the primary focus of sales compensation should be on direct financial rewards (base pay plus incentives). Organizational Strategy A sales compensation plan should link desired behaviors of salespeople to organizational strategy.49 This is particularly true in the Internet age. As more sales dollars are tied to computer-based transactions, the role of sales personnel will change.50 Salespeople must know when to stress customer service and when to stress volume sales. And when volume sales are the goal, which products should be pushed hardest? Strategic plans signal which behaviors are important. For example, emphasis on customer service to build market share or movement into geographic areas with low potential may limit sales volume. Ordinarily, sales representatives under an incentive system will view customer service as an imposition, taking away from money-making sales opportunities. And woe be to the sales supervisor who assigns a commission-based sales person to a market with low sales potential. Salespeople who are asked to forgo incentive income for low-sales tasks should be covered under a compensation system with a high base pay and small incentive component. Alternatively, an organization may want to motivate aggressive sales behavior. A straight commission-based incentive plan will focus sales efforts in this direction, to the possible exclusion of supportive tasks such as processing customer returns. Such incentive plans include both a statement about the size of the incentive and a discussion of the performance objective necessary to achieve the incentive. Typical performance measures include overall territory volume, market share, number of product placements in retail stores, number of new accounts, gross profit, percentage of list-price attainment (relative to other salespeople in the organization), consistency of sales results, expense control, productivity per square foot (especially popular in retail stores), and bad debt generated by sales. 51 Each measure, of course, corresponds to a different business goal. For exam-

48Charles

Warner, “Recognition and Appreciation Is Vital for Salespeople,” www.charleswarner .us/recogsls.html, retrieved April 10, 2003. 49Bill O’Connell, “Dead Solid Perfect: Achieving Sales Compensation Alignment,” Compensation and Benefits Review, March/April 1996, pp. 41–48. 50B.

Weeks, “Setting Sales Force Compensation in the Internet Age,” Compensation and Benefits Review, March/April 2000, pp. 25–34. 51John

K. Moynahan, The Sales Compensation Handbook (New York: AMACOM, 1991).






ple, an orga nizati on mig ht use a volume measure such as number of units, orders, invoices, or cash received if the business goal is to increase sales growth. Alternatively, if the goal is profit improvement, the appropriate measurement would be gross margin on sales or price per unit. Percentage account erosion would be stressed if improved account retention became a major focus of attention, while customer satisfaction indices are increasingly popular because of greater emphasis on quality. Market Maturity As the market of a product matures, the sales pattern for that product will change, and companies need to adapt the compensation for their sales force accordingly. A recent study showed that with maturing markets, companies move toward a more conservative sales pattern, focusing even more on customer satisfaction and retention. This leads companies to employ more conservative, rather than aggressive, sales people, who can comply with the companies’ customer retention plans. In maturing markets, companies focus both on performance-based pay tied to customer satisfaction and on greater base salaries to retain conservative salespeople. 52 Competitor Practices In selecting an appropriate pay level, organizations should recognize that external competitiveness is essential. The very nature of sales positions means that competitors will cross paths, at least in their quest for potential customers. This provides the opportunity to chat about relative compensation packages, an opportunity which salespeople will frequently take. To ensure that the comparison is favorable, the organization should identify a compensation strategy that explicitly indicates target salaries for different sales groups and performance levels. Size of Company As Exhibit 14.10 shows, the total compensation for sales personnel varies with the size of the company. For executive sales staff the total compensation varies by as much as 50 percent; for normal sales staff, by as m uch as 44 percent. Economic Environment The economic environment also affects the way a compensation package is structured. In good economic climates with roaring sales, companies can afford to hire mid- and low-level sales personnel to capture the extra sales. In a recession environment, however, companies need to react to the decreasing level of sales by focusing more on the top-level performers and rewarding those that achieve high levels of sales despite the economic downturn. In the downturn of 2001 mid- and low-level performers’ total compensation was down about 10 percent from the year before, while top performers increased their total compensation by an average of 9.3 percent. The difference in compensation is even greater when looking at the incentive part of total compensation. While base salaries rose for all levels of performance, incentive-based pay was up by 7.6 percent for top performers, but down by over 30 percent for mid- and low-level performers. About 30 percent of all managers reported a decrease in total head count, and only 34 percent reported an increase in head count. 53 For the economic recovery of 2003, 48 percent of managers expected an increase in sales force total compensation for that year, 2002, and less than 20 percent expected a decrease.54

52”Where 53C.

Is Sales Compensation Heading in 2003?” Workspan, January 1, 2003. Galea, “2002 Salary Survey,” Sales and Marketing Management, May 1, 2003.

54”Sales

Pay Rising,” Sales and Marketing Management, February 1, 2003.





Chapter 14


EXHIBIT 14.10 Sales Compensation Rises with Company Revenue Total Compensation Annual Revenue of Company Less than $1,000,000 $1,000,000–$9,999,999 $10,000,000–$49,999,999 $50,000,000–$249,999,999 $250,000,000–$999,999,999 $1 billion–$10 billion More than $10 billion

Sales Executives

Sales Staff

$92,053 103,759 124,611 127,597 138,903 142,839 138,490

$69,081 70,289 75,868 82,289 85,169 95,240 99,897

Source: C. Galea, “2002 Salary Survey,” Sales and Marketing Management, May 1, 2003.

Product to Be Sold The nature of the product or service to be sold may influence the design of a compensation system. For a product that, by its very technical nature, is difficult to understand, it will take time to fully develop an effective sales presentation. Such products are said to have high barriers to entry, meaning considerable training is needed to become effective in the field. Compensation in this situation usually includes a large base-pay component, thus minimizing the risk a sales representative will face and encouraging entry into the necessary training program. At the opposite extreme are products with lower barriers to entry, where the knowledge needed to make an effective sales presentation is relatively easy to acquire. These product lines are sold more often using a higher incentive component, thus paying more for actual sales than for taking the time to learn the necessary skills. Products or services that sell themselves, where sales ability isn’t as crucial, inspire different compensation packages than do opportunities where the salesperson is more prominent. Base compensation tends to be more important with easily sold products. Not surprisingly, incentives become more important when willingness to work hard may make the difference between success and failure. One recent study argues convincingly that setting sales targets or quotas is the most important, and most difficult, part of sales compensation. Several factors can help you determine whether your quotas are reasonable: (1) Can the sales force tell you explicitly how the quotas are set? (2) In periods when the company hits its performance target does 60 to 70 percent of the sales force hit quota? (3) Do high performers hit their target consistently? (4) Do low performers show improvement over time?55 Most jobs do not fit the ideal specifications for either of the two extremes represented by straight salary or straight commission plans. A combinati on plan is intended to capture the best of both these plans. A guaranteed straight salary can be linked to performance of nonsales functions such as customer service, while a commission for sales volume yields the incentive to sell. A plan combining these two features signals the intent of the organization to ensure that both types of activities occur in the organization. 55S.

Sands, “Ineffective Quotas: The Hidden Threat to Sales Compensation Plans,” Compensation and Benefits Review, March/April 2000, pp. 35–42.






Contingent Workers Ninety percent of all U.S. employers hire contingent workers.56 Let’s define a contingent worker as anyone hired through a temporary-help agency, on an on-call basis, or as an independent contractor. Workers in the first two of these categories typically earn less than workers in traditional arrangements; those in the latter category earn more. For example, working through a temporary-help agency usually means low pay in administrative or day labor positions. In contrast, the wages for an independent contractor might be higher than those for a more permanently employed counterpart. Indeed, independent contractors often are people who have been downsized and then reemployed by the company. DuPont cut its work force by 47,000 during the 1990s. About 14,000 of these workers were subsequently hired as vendors or contractors. 57 Because the employment status of contingent workers is temporary and employee benefits are less or nonexistent, wages at times tend to compensate by being somewhat higher. Why the move to contingent workers? Part of the answer may be cost savings. Em ployee benefit costs are about 50 percent less for contingent workers.58 But sometimes wages are higher. The main reason for contingent workers may be the added flexibility such employment offers the employer. In today’s fast-paced marketplace, lean and flexi ble are desirable characteristics, and contingent workers offer these options. A major compensation challenge for contingent workers, as with all our special-group employees, is identifying ways to deal with equity problems. Contingent workers may work alongside permanent workers yet often receive lower wages and benefits for the same work. Employers deal with this potential source of inequity on two fronts, one traditional and one that challenges the very way we think about employment and careers. One company response is to view contingent workers as a pool of candidates for more permanent hiring status. High performers may be moved off contingent status and afforded more employment stability. Cummins Engine, for example, is famous for its hiring of top-performing contingent workers. The traditional reward of a possible “promotion,” then, becomes a motivation to perform. A second way to look at contingent workers is to champion the idea of boundaryless careers.59 At least for high-skilled contingent workers, it is increasingly popular to view careers as a series of opportunities to acquire valuable increments in knowledge and skills. In this framework, contingent status isn’t a penalty or cause of dissatisfaction. Rather, employees who accept the idea of boundaryless careers may view contingent status as part of a fast-track developmental sequence. Lower wages are offset by opportunities for rapid development of skills—opportunities that might not be so readily available in more traditional employment arrangements. Companies like General Electric that promote this reward—enhanced employability status through acquisition of highly demanded skills—may actually have tapped an underutilized reward dimension. 56P.

Allan, “The Contingent Workforce: Challenges and New Directions,” American Business Review, 20(2) (2002), pp. 103–110. 57Kim Clark, “Manufacturing’s Hidden Asset: Temp Workers,” Fortune, November 10, 1997, pp. 28–29. 58Ibid. 59Janet

H. Marler, George T. Milkovich, and Melissa Barringer, “Boundaryless Organizations and Boundaryless Careers: A New Market for High Skilled Temporary Work,” unpublished paper submitted to 1998 Academy of Management annual conference, Human Resource Division.





Chapter 14

Your Turn


Compensation of Special Groups

You are the CEO of a 110-person consulting firm, Sierra Avo, that does high-level aeronautical engineering work for Boeing. You have 15 aeronautical engineers hired from the very best schools throughout the country. The problem is, six months ago you had 19 such engineers. Four have left recently, and rumors have it that some of the others are disgruntled. Exhibit 1 lists characteristics of the four engineers who left. The salaries of the remaining 15, and some other data you might find useful, are shown in Exhibit 2. 1. Do you see anything in the data that might explain why workers are leaving. Justify your arguments based on the reasoning given in the chapter for changes in scientist/engineer salaries. Do your arguments fit for Lance Welch also? If not, is there anything about current economic conditions that might explain his salary? Would you be surprised to hear he left for another job offer? Why? 2. Now that you’ve explained why people are leaving, should you change salaries to reduce the turnover? What are the economic arguments for not increasing wages? 3. Assume your company has created a two-track career path for engineers. On one path, senior engineers serve as managers who also specialize in client relations. How might this change the nature of your argument about wages?

EXHIBIT 1 Workers Who Left

Name Sam Lansing Naresh Rao Lance Welch Kim Lee

Degree B.S. M.S. B.S. Ph.D

Years since Degree Received

Annual Salary

Performance Rating

11 10 1 10

$61,000 $69,300 $37,000 $87,238

Good Excellent New (no rating) Good






EXHIBIT 2 Workers Who Remain

Summary

Employee

Highest Relevant Degree Received

Years since Degree Received

B.S. M.S. M.S. Ph.D. B.S. Ph.D. M.S. Ph.D. B.S. Ph.D. M.S. M.S. Ph.D. B.S. B.S.

3 6 3 7 6 9 4 3 7 6 9 7 4 9 4

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Annual Salary $ 39,000 $ 58,800 $ 50,400 $ 95,900 $ 48,000 $ 105,300 $ 53,200 $ 77,100 $ 51,000 $ 91,200 $ 67,200 $ 61,600 $ 81,800 $ 57,000 $ 42,000

Special groups are portrayed here as sharing two common characteristics: They all have jobs with high potential for conflict, and resolution of this conflict is central to the goals of the organization. Probably because of these characteristics, special groups receive compensation treatment that differs from the approach for other employees. Unfortunately, most of this compensation differentiation is prescriptive in nature, and little is known about the specific roles assumed by special groups and the functions compensation should assume in motivating appropriate performance. Future practice and research should focus on answering these questions.

Review Questions 1. What are the sources of monetary savings from hiring contingent workers? What equity problems can arise from hiring contingent workers, especially when they work alongside regular employees. 2. In recent years the newspapers have been full of stories about the excessive pay to CEOs. Assume you are a CEO trained in economics (you went to a good school, like SUNY Buffalo or Cornell). What arguments might you give in support of your com pensation? Would LeBron James (number-one draft pick in the NBA for 2003) agree with these arguments? 3. From question 2, what might be the counterarguments from a critic of CEO compensation? (Be sure to include performance arguments and both internal and external equity arguments.) 4. Would you expect computer programmers to be treated as special groups (in the way defined in this chapter) in a company like Microsoft? If so, what special compensation practices might you expect for these programmers? Why? 5. A board of directors meets perhaps 12 times a year for a day (usually). How can we possibly justify to stockholders paying this group tens of thousands of dollars for this brief time period?

Compensation of Special Groups

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