International human resource management lesson 07

7 COMPENSATION AND INCENTIVES CONTENTS 7.0 Aims and Objectives 7.1 Introduction 7.2 Designing Compensation Programme 7.2.1 Compensation 7.2.2 Employee Benefits 7.2.3 Objectives of Intern

7

COMPENSATION AND INCENTIVES

CONTENTS

7.0 Aims and Objectives

7.1 Introduction

7.2 Designing Compensation Programme

7.2.1 Compensation

7.2.2 Employee Benefits

7.2.3 Objectives of International Compensation

7.3 Approaches to International Compensation

7.3.1 Going Rate Approach

7.3.2 Balance Sheet Approach

7.4 Factors Affecting International Compensation System

7.4.1 Host Country Market Cost of Living

7.4.2 Nature of the Expatriate Job

7.4.3 Culture Adjustment

7.4.4 International Living Cost Data

7.5 International Benefits

7.6 Adjustments and Incentives

7.6.1 Base Salary

7.6.2 Foreign Service Inducement/Hardship Premium

7.6.3 Allowances

7.6.4 Differentiating between PCNs and TCNs

7.6.5 Termination of Contract

7.6.6 Incentives and Corporate Commitments

7.7 Japanese Model and Matsushita

7.8 Let us Sum up

7.9 Lesson End Activity

7.10 Keywords

7.11 Questions for Discussion

7.12 Suggested Readings

7.0 AIMS AND OBJECTIVES

After studying this lesson, you will be able to:

 Define international compensation and benefits

 Describe various components of international compensation

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 Know what are the various approaches of international compensation

 Explain factors that affect international compensation system

7.1 INTRODUCTION

Worker compensation tends to vary widely around the business world Consider, for example, a comparison between U.S and Chinese worker compensation First all, the average wage of the Chinese worker is only about 3 to 5% of that of the U.S worker, but the Chinese are not required to pay income tax, insurance premiums, or pension plan payments In addition, Chinese housing costs only about one dollar a month, so the difference in net income is not as large as first indicated, although the differential is still

significant In Japan, compensation is based on the traditional Oyabun-Kobun, or

parent-child relationship, in which pay and promotions are determined almost entirely by seniority

In the new European Community (EC), efforts are progressing to establish Europay, by

which member nations would develop common policies regarding employment practices, especially compensation (Markland, 1987) Employee benefits also vary by country For instance, benefits and employee perks constitute a much greater share of the overall compensation package in Europe than in America Cross-cultural differences impact the importance of benefits For instance, vacation time is not an important benefit to the Japanese worker, who seldom takes more than three or four days off in a year However, vacation and holiday time-off is critical in Africa, most Muslim nations, and some Latin American countries

7.2 DESIGNING COMPENSATION PROGRAMME

HR executives in global firms spend a great deal of time and effort in designing and managing compensation programmes, because of their high costs and impact on corporate performance, commitment of employees and their retention Compensation also influences organisational culture, recruitment and selection of competent employees, motivation and performance Then there are issues in designing compensation programmes, such

as parity between HCNs and PCNs, state of the labour market and relevant national laws and practices

Compensation decisions are strategic decisions and play a key role in achieving performance and sustainable competitive advantage for international firms These policy decisions should be consistent with the overall strategy, structure and business needs of the multinational Second, the policy should attract and retain the best staff in those areas where the firm has greatest needs and opportunities and where its core competency lies Third, the policy must facilitate the transfer of international employees in a cost effective manner Fourth, the policy should give due consideration to equity and ease of administration It should reduce cost of operations and enhance commitment of employees

It should also facilitate international posting and transfer of employees (Gupta, 2006) These policy decisions regarding compensation and benefits require the knowledge of employment and taxation laws, customs, cost of living index, environment, employment practices of various countries and so on Without such comprehensive knowledge and database, the corporate HR executive will not be able to advise expatriates regarding avoidance of double taxation or to reimburse the actual costs or decide about incentives that will encourage employees to take up foreign assignments

In addition, the knowledge of labour markets and industry norms regarding benefits and compensation is also necessary In order to ensure equity with PCNs, the salary of

133 Compensation and Incentives

expatriates has to be adjusted for foreign currency fluctuations of the two countries

unless they are paid full salary and allowances in the home country currency If the

expatriates are paid in local currency, then their salary should also be adjusted for rise in

the cost of living in that country from time to time Hence HR managers have to

continuously watch foreign exchange rate fluctuations and monitor rate of inflation or

cost of living index in different countries

For multinational firms, successful management of compensation and benefits requires

knowledge of the employment and taxation laws, customs, environment, and employment

practices of many foreign countries Also needed are familiarity with currency fluctuations

and the effect of inflation on compensation, and an understanding of why and when

special allowances must be supplied and which allowances are necessary in what countries

All of these needs must be fulfilled within the context of shifting political, economic, and

social conditions

Because of their high-cost, HR managers spend a general a great deal of time developing

effective compensation and benefit programs for international employees A recent report

in Fortune on doing business in China (Tomlmson; 1997) reported that hiring a local

Chinese manager with 15 years of experience would cost less than U.S.$70,000; a U.S

expatriate chief financial officer would cost U.S.$300,000 with the following compensation

package (all figures in U.S.$):

Benefits:

Rest and Rehabilitation 10,000 Private school for children 25,000

While a driver may be considered a luxury in most Western countries, available only to

CEOs, in developing economies a driver is both economical in terms of cost and it is in

the interests of the multinational to provide this benefit Apart from the practical realities

that managers are expected to have a driver, parking is frequently chaotic in developing

countries (especially in large cities) and the driver also performs the function of a parking

attendant It can also be quite dangerous for expatriates to drive in certain developing

countries For example, in some developing countries it is quite common for the police to

arrest drivers involved in traffic accidents and keep them in detention while the matter is

sorted out in terms of responsibility and damages Such a risk is unacceptable to most

firms and many multinationals do not allow their expatriate employees to drive at all in

certain developing countries and provide local drivers for both the expatriate and spouse

7.2.1 Compensation

Compensation may be defined as the financial remuneration the employees receive in

exchange for their labour Compensation management deals with wages, salaries, pay

increase, and other monetary issues The compensation system is designed to reward

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employees is an equitable manner and to serve as an inducement for the attraction and retention of a good workforce Cherrington (1991) writes that compensation decisions should achieve six critical objectives:

1 Be legal: Compensation decisions should be consistent with federal, state, and

local laws and regulation

2 Be adequate: Compensation should be sufficient to attract qualified job applications

and retain them

3 Be motivating: Compensation should be sufficient to provide the necessary

incentives to motivate employees to high performance levels

4 Be equitable: Employees should be made to feel that the compensation system is

equitable

5 Provide security: Employees should be made to feel that their income is secure

and predictable

6 Be cost-benefit effective: The employing organisation should administer the

compensation system effectively

The design of a wage and salary structure begins with the job evaluation, which is the process of assessing the values of the jobs within the organisation The most common job evaluation system is the point system, which is accomplished in seven steps:

1 Perform a job analysis and document or update the job descriptions

2 Choose a point-based job evaluation, that assigns point values for the various skills and responsibilities inherent in the jobs

3 Use the point-based evaluation to assess the value of the jobs

4 Select the key jobs and obtain a pay survey to establish their market pay rates

5 Compare the survey pay rates for the key jobs with their job evaluation points by

plotting a pay-trend line on a graph.

6 From the pay-time line, assign average pay rates to the non-key jobs

7 Group the jobs into categories and establish pay ranges within each categories (Daft; 1991)

7.2.2 Employee Benefits

Benefit management is concerned with the administration of insurance, pensions,

vacations, educational benefits, and other matters of value to the employee Because benefits are usually of a monetary nature, they are coordinated closely with compensation management Benefit programmes are based on three critical philosophies: (1) sharing the risks of illness and injury; (2) forced savings for that ‘rainy day’; and (3) sharing the costs of special human services (Cherrington; 1991) Specifically, optional employee benefits may be categorised as health and accident insurance, life insurance, income continuation, pay for time off (vacations, holidays, sabbaticals, etc.), and employee services such as employee assistance programmes:

7.2.3 Objectives of International Compensation

When developing international compensation policies, a firm seeks to satisfy several objectives First, the policy should be consistent with the overall strategy, structure, and

135 Compensation and Incentives

business needs of the multinational Second, the policy must work to attract and retain

staff in the areas where the multinational has the greatest needs and opportunities Third,

the policy should facilitate the transfer of international employees in the most cost-effective

manner for the firm Fourth, the policy must give due consideration to equity and ease of

administration

The international employee will also have a number of objectives that need to be achieved

from the firm’s compensation policy First, the employee will expect that the policy offers

financial protection in terms of benefits, social security, and living costs in the foreign

location Second, the employee will expect that a foreign assignment will offer opportunities

for financial advancement through income and/or savings Third, the employee, will expect

that issues such as housing, education of children, and recreation will be addressed in

the policy

7.3 APPROACHES TO INTERNATIONAL

COMPENSATION

There are two main options in the area of international compensation—the Going Rate

approach and the Balance Sheet Approach.

7.3.1 Going Rate Approach

The key characteristics of this approach are summarized in Figure 7.1 With this approach,

the base salary for international transfer is linked to the salary structure in the host

country The multinational usually obtains information from local compensation surveys

and must decide whether local nationals (HCNs), expatriates of the same nationality, or

expatriates of all nationalities will be the reference point terms of benchmarking

For example, a Japanese bank operating in New York would need to decide whether its

reference point would be local U.S salaries, other Japanese competitors in New York,

or all foreign banks operating in New York With the Going Rate Approach, if the location

is in a low-pay country, the multinational usually supplements base pay with additional

benefits and payments

 Based on local market rates

 Relies on survey comparisons

 Local nationals (HCNs)

 Expatriates of same nationality

 Expatriates of all nationalities

 Compensation based on the selected survey comparison

 Base pay and benefits may be supplemented by additional payments for low-pay countries.

Figure 7.1: Going Rate Approach

There are advantages and disadvantages of the Going Rate Approach that are summarized

in Figure 7.2 Advantages include: equality with local nationals (very effective in attracting

PCNs or TCNs to a location that pays higher salaries than those received in the home

country), approach is simple and easy for expatriates to understand, expatriates are able

to identify with the host country, and there is often equity among expatriates of different

nationalities

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Advantages Disadvantages

Equally with local nationals Variation between assignments for same employees Simplicity Variation between expatriates of same nationality in

different countries.

Identification with host country Potential re-entry problems nationalities

Figure 7.2: Advantages and Disadvantages of the Going Rate Approach

7.3.2 Balance Sheet Approach

The key characteristics of this approach (the most widely used approach for international compensation) are summarized in Figure 7.3 The basic objective is to “keep the expatriate whole” (Teague, 1972) (i.e., maintaining relatively to PCN colleagues, and compensating for the costs of an international assignment) through maintenance of home-country living standard, plus a financial inducement to make the package attractive The approach links the base salary for PCNs and TCNs to the salary structure of the relevant home country For example, a U.S executive taking up an international position would have his

or her compensation package built on the U.S base-salary level rather than that applicable

to the host country The key assumption of this approach is that foreign assignees should not suffer a material loss due their transfer, and this is accomplished through the utilization

of what is generally referred to as the balance sheet approach.

 The basic objective is maintenance of home-country living standard, plus financial inducements

 Home-country pay and benefits are the foundations of this approach

 Adjustment to home package to balance additional expenditure in host country

 Financial incentives (expatriate/hardship premium) added to make the package attractive

 Most common system in usage by multinational firms

Figure 7.3: Balance Sheet Approach

There are four major categories of outlays incurred by expatriates that are incorporated

in the balance sheet approach (Dowling, etc 2001):

1 Goods and services—home-country outlays for items such as food, personal care,

clothing, household furnishings, recreation, transportation, and medical care

2 Housing—major costs associated with housing in the host country.

3 Income taxes—parent-country and host-country income taxes.

4 Reserve—contributions to savings, payments for benefits, pension contributions,

investments, education expenses, social security taxes, and so on

Where costs associated with the host-country assignment exceed equivalent costs in the parent country, these costs are met by both the firm and the expatriate to ensure that parent-country equivalent purchasing power is achieved

137 Compensation and Incentives

Employee: Brian Smith

Position: Marketing Manager

Reason for change: New Assignment

Effective date of change: 1 February 1998

Item Amount

A$ PA

Paid in A$ PA

Paid in local currency NE$

PA

Base salary

Cost of living allowance

Overseas service premium (20%)

Hardship allowance (20%)

Housing deduction (7%)

Tax deduction

135,000 33,750 27,000 27,000 -9,450 -51,079

67,500

27,000 27,000 -9,450 -51,079

101,250 50,625

COLA Index = 1500

Exchange Rate = 1.5 Authorized / Date

Figure 7.4: Expatriate Compensation Worksheet

Figure 7.4 shows a typical spreadsheet for an expatriate assignment using the balance

sheet approach In this example, an Australian expatriate is assigned to a country called

New Euphoria which has a COLA index of 150 relative to Australia, and an exchange

rate of 1.5 relative to the A$ In addition to a foreign service premium, a hardship allowance

is also payable for this location Housing is provided by the firm, and a national cost for

this is recognized by a 7% deduction from the package, along with a national tax deduction

The expatriate can see from this spreadsheet what components are offered in the package

and how the package split between Australian currency and New Euphoria currency

There are advantages and disadvantages of the balance sheet approach, which are

summarized in Figure 7.5

Advantages Disadvantages

 Equity  Can result in great disparities

 between assignments  between expatriates of different nationalities

 between expatriates of the  between expatriates and local nationals

same nationality

 Facilities expatriates re-entry  Can be quite complex to administer

 Easy to communicate to employees

Figure 7.5: Advantages and Disadvantages of the Balance Sheet Approach

Check Your Progress 1

1 What is balance sheet approach of international compensation management?

2 Mention the salient features of the going rate approach

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7.4 FACTORS AFFECTING INTERNATIONAL COMPENSATION SYSTEM

To keep employees whole “is the goal of expatriate compensation (Omig, 1999, p40) In order to maintain expatriates’ feeling “wholeness”, organizations need to consider following

factors (Robert et al.)

7.4.1 Host Country Market Cost of Living

Scholars suggest that cost of living in the host country is the greatest impact on expatriate compensation (Frazee, 1998b, Overman, 2000) Also housing, children’s education, and healthcare costs are the details need to be discussed when people considering the cost

of living in the host country (Robert et al) For example, an expatriate family leaves their

own American and move to Japan, May be their home used to be a big house located in

a quite suburb But now their rooms are small apartment stated in central area in Tokyo

It will be a big changing for them and it is very hard for these family members to start their new life (Omig, 1999) Also expatriate employee can not do his (her) assignment very well In order to make sure expatriates’ working quality, compensation package should include the detail about housing change, introduce the new environment, list advantage and disadvantage of these changing Then expatriates know what will happen

in the future and also they can do lots of prepare to adopt the new home

Then about healthcare, healthcare is also one of important factors of compensation package according the research by Frazee (1998a) Lots of international company have different insurer between home country and expatriate For instance, the expatriate worked in Hong Kong, while the insurer is Australian In this situation, normally the claims document is finished in Chinese But it is so inconvenient for the Australian headquarters reading this work It should be translated and will take a long time (Franzee, 1998) So these days, some enterprises contracting with insurance company which have special plan for expatriates These plans including special progress to deal with expatriates’

claim more quickly than normal company (Robert et al).

7.4.2 Nature of the Expatriate Job

The nature of the expatriate job is very important for the whole expatriate management system (Tahvanainen, 2000) Expatriate employees want to achieve different tasks based

on the different nature of their job (His-An Shih et al, 2003) This also means “expatriate

performance appraisal should according to the nature of the expatriate mission”

(His-An Shih et al, 2003) The difficult part for the expatriate manager is that the nature of

their job is defined by their home country, but performed in host country (Peter and Denice 2004) Especially when the expatriate need to complete important tasks and stay

at host country for long time, the host country manager will be involved more in the expatriate objects’ decision (Tahvanainen, 2000)

Scholars do some research about expatriates of four information technology industry who worked in Taiwan They found different nature of the expatriate’s mission related

to different goal-setting arrangement Hitachi (Japan), Philips (Dutch), Samsung (Korea) use the same way: the host country manager approbate the goals set by expatriates

(His-An Shis et al, 2003).

“I need to set my own work goals every six months and discuss them with my direct supervisor here (Philip).”

“We have to set our own performance goals and get our (host) manager’s approved (Samsung)” But Applied Materials Taiwan’s expatriates set their performance after they satisfied their clients

139 Compensation and Incentives

“We are also evaluated by our clients for instance, part of my performance goals is

decided jointly by my boss and my client firm’s executives (AMT)” (His-An Shih et al,

2003) These findings provides hypothetic to EPM model which suggested Tchvaneiner

(1998) And this model can help MNEs improve their global management to get

competitive advantage

7.4.3 Culture Adjustment

From past experience, hard to accept the new environment and difficult to operate

effectively are main problems for most expatriates (Brewster and Harries, 1999)

Pre-departure training, like language and sensitive training is very important for improving

expatriates’ culture awareness and cross-culture suitability (Dowling et al, 1999).

However, lots multinationals’ cross-culture training is not enough Some are insufficient,

some are incomplete (Brewster, 1995; Waxin et al., 1997, Selmer, 2000) Why these

things happen? Because it’s very hard to evaluate the effectiveness of such training

(Marie-France Waxin et al) Teaching expatriate employees from one culture to

coordinate with people of another culture is the goal of cross-culture training (Brislin and

Peterson, 1986; Mendenhall and Oddou, 1991) For example, these days more and more

multinational companies enter Chinese market There is one crucial reason decide success

or failure of multinational enterprise This reason is culture difference (Zhuang, 2003)

Scholars suggest expatiates managers should pay attention to two aspects, “how to

handle culture difference, how to effectively communicate with staff members.” (Yuan

qiang, zhou et al.,) Also there are some research about one American company and one

European company conduct in China The American company believes training is a

good way to make expatriate employees recognize the host country culture and

communication is useful to reduce the gap of difference

The European company considers culture fusing by training and providing opportunities,

like business travels and making people appreciate different culture Communication is

the most useful way to deal with the misunderstanding problems between expatriate

managers and local staffs (Yuan qiang, zhou et al.) Both of these companies have

common sense on the culture identification They all believe culture identification should

be realized through training and daily influence (Yuan qiang, zhou et al.,) Also some

global company offer extensive pre-departure training, such as culture awareness

programs: “I attend Chinese classes three months before my assignment here (Samsung

manger) In conclusion, researches show cross-culture training already has positive effect

on culture adjustment

7.4.4 International Living Costs Data

Obtaining up-to-date information on international living costs is a constant issue for

multinationals The level of local knowledge required in many areas of international

HRM requires specialized advice Consequently, many multinationals retain the services

of consulting firms that may offer a broad range of services or provide highly specialized

services relevant to HRM in the multinational context With regard to international living

coasts, a number of consulting firms offer regular surveys calculating cost-of-living index

that can be updated in terms of currency exchange rates A recent survey of living costs

(Finfacts, 2003) in selected cities ranked the ten most expensive cities as Tokyo, Moscow,

Okasa, Hong Kong, Beijing, Geneva, London, Seoul, Zurich and New York The least

expensive city was Asuncion (Paraguay)

Multinationals using the balance sheet approach must constantly update compensation

packages with new data on living costs, an on-going administrative requirement This is

an issue to which expatriate employees pay great attention, and forms the basis of many

complaints if updating substantially lags behind any rise in living costs Multinationals

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must also be able to respond to unexpected events, such as the currency and stock market crash that suddenly occurred in a number of Asian countries in late 1997 Some countries, such as Indonesia, faced a devaluation of their currency by over 50% against the U.S dollar in a matter of weeks, which had a dramatic impact on prices and the cost

of living

It is also to take a wider view and focus on business costs rather than living costs for

expatriates, because the multinational firm is interested in the overall cost of doing business

in a particular country as well as the more micro issue of expatriate living costs Germany is the most expensive country overall because of its very high basic wages, while the second most expensive rank for the United States is in large part because of high executive salaries In general, developed countries rank as more expensive than developing countries because their wage costs are higher

7.5 INTERNATIONAL BENEFITS

The complexity inherent in international benefits often brings more difficulties than when dealing with compensation Pension plans are very difficult to deal with country to country because national practices vary considerably Transportability of pension plans, medical coverage, and social security benefits are very difficult to normalize Therefore, firms need to address many issues when considering benefits

Most U.S PCNs typically remain under their home-country’s benefit plan In some countries, expatriates cannot opt out of local social security programmes; in such circumstances, the firm normally pays for these additional costs European PCNs and TCNs enjoy portable social security benefits within the European Union

Multinationals also provide vacations and special leave Included as part of the employee’s regular vacation, annual home leave usually provides airfares for families to return to their home countries Rest and rehabilitation leave, based on the conditions of the host country, also provides the employee’s family with free airfares to a more comfortable location near the host country Emergency provisions are available in case of a death or illness in the family Employees in hardship locations often receive additional leave expense payments and rest and rehabilitation periods (Dowling, etc 2001)

7.6 ADJUSTMENTS AND INCENTIVES

If we contrast the objectives of the multinational and the employee we see the potential for many complexities and possible problems, since some of these objectives cannot be maximized on both sides The area of international compensation is complex primarily because multinationals must cater for three categories of employees: PCNs, TCNs, and HCNs The key components of international compensation include base salary, foreign service inducement/hardship programme, allowances, and benefits

7.6.1 Base Salary

The term base salary acquires a somewhat different meaning when employees go

abroad In a domestic context, base salary denotes the amount of cash compensation that serves as a benchmark for other compensation elements (e.g., bonuses and benefits) For expatriates, it is the primary component of a package of allowances, many of which are directly related to base salary (e.g., foreign service premium, cost-of-living allowance, housing allowance) as well as the basis for in-service benefits and pension contributions The base salary is the foundation block for international compensation and the employee’s package depending on whether the base salary is linked to the home country of the PCN

or TCN or whether an international rate is paid