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Human values in organisations

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1.      Introduction

 

      Designing manager’s compensation schemes  is one of the most important, most specialized and challenging tasks for human recourse manager. Managers are “one of kind” individuals, who are hired to take some responsibility of leading or directing the whole organization or a project. Their decisions are pivotal in developing overall organizational objectives, policies and business strategies, poor decision may lead to negative consequences for entire organization. Nowadays it’s became common sense, when managers are rewarded not only by salaries, retirement and health benefits, but also company’s shares and stock options. In this respect complexity of manager’s compensation schemes appears in two dimensions:

-         content of compensation scheme and it’s value;

-         defining performance and the time frame used for reward distribution.

 

   While the first dimension will be discussed later and in this project, the second must be discussed now. Paying for short-term performance gains, such as successfully finished project or reached monthly profit,  may neglect long-term performance, such as company’s strategic goals or a particular brand’s  market share. But it is also questionable logic to make manager wholly or even partially accountable for the firm’s performance because it depends on many factors that are beyond the manager’s control.

   For example, if a head of Strategic Business Unit of a certain organization is risk averse person, who receives basic compensation packet plus some percentage of profits, suddenly begins receiving only percentage of profit as a salary, the SBU’s stability will be questioned. We can distinguish two outcomes in this situation: either this person would feel completely uncomfortable (as a risk averse person) and soon will leave the company, or he would lose control at the economical/market situation and will make wrong decisions. Both these outcomes are negative for a company and may be possible when a manager became completely responsible for the company’s performance.

     Companies may also have different approaches to manager’s work compensation in regard to the level of autonomy, associated with the phase of organization’s growth[5]. Division manager in firm, entering Phase 3, generally experience more autonomy than do his colleague in firm, being in Phase 2, or entering Phase 4, where he has both much responsibility and necessity to “justify actions to a “watchdog” audience at headquarters” [5]. As a consequence, he is better able to link rewards (bonuses, compensations packages) to own performance.     

   There are many alternative theories, which suggest different approaches to this problem. For example, Deckop [4] argue, that manager’s performance should be evaluated on global factors, such as “internal leadership”, “dealing with various constituent groups outside the firm”. Steers [3] agrees with this, but concludes also that political factors are more important in setting manager’s pay than “bottom line” performance measures.

 

    This and all other problems, which appear when company designs and implements  managers’ compensation schemes, are avoided if the compensation system is integrated into overall business strategy. It means that organization must develop strategies to achieve its ultimate goals and in this process it establishes programs and activities to accomplish them. Many supporting systems help organization achieve its objectives, compensation is one of them, along with marketing, finance, production and other functions. Firm can not be successful in its management compensation strategies over  the long term,  unless they are coordinated with other organizational subsystems and designed to reinforce the strategy adopted by the entire organization.

    Changes in the business environment are making it necessary for firms to create new and review old approaches in  management compensation schemes. For example, it will be illustrated later, how changed perception of stock option schemes from 60’s to 90’s, and which trends in this phenomenon exist now.    

 

2. The role of politics in manager’s compensation.

 

   Mintzberg [6] suggests that managers spend considerable time acting as political figures in their organizations. In this respect, their work may be described as managing internal coalitions and transactions between these coalitions and external constituencies; one of the most important goals in their political games is to obtain adequate compensation package. Among reasons for this are following:

-         to receive external confirmation of own importance, qualification, experience, leadership ability;

-         to  be able participate in overall company ‘s decision making (in case of rewarding by company’s shares), or at least , to feel close relation to company;

-         to accompany legitimate and illegitimate systems of influence, obtained in an organization: place in organizational hierarchy, ability to make decisions and implement changes.

    

I would like to underline two types of power games: Expertise and Budgeting, because they are the most relevant in this project.  They both based on knowledge, education, work experience, and even uniqueness of a player. The small difference is in goals. If an expert’s explicit goal is compensation package and work conditions, for line manager[1], it is also status in an organization. “Darwinian” function role of politics [6] for a line manager is very important, because he must ensure stability of own leadership position in eyes of subordinates and supervisors. This stability is reached partly by designing sound compensation package. For example, giving a stock option, which can not be exercised for 10 years, but nevertheless, has a solid market value, may demonstrate  to a manager- company’s care about him, and to manager’s subordinates- his importance, level of authority and value in organization.

 

Mintzberg [6] gives also detailed characteristics of  other related to this project games: Sponsorship, Alliance Building, Empire Building, Strategic Candidates. Except that they are coexistent  with legitimate systems of power, all of them (and other, not mentioned here, too) have other common feature: receiving adequate reward for invested in company knowledge, education, skills, time and efforts.       

 

     It is possible to mention also Centralization power game by top managers, but issue of rewarding top executives is rather different than one of  ordinary managers, because of their much bigger influence and status. In the context of politics, top executives, serve as symbolic figures and  political strategists at their organizations, who manage both internal and external  political coalitions. Most obvious example are maneuverings that characterize mergers and acquisitions. In terms of compensations these political and symbolic activities are difficult to evaluate. They are not always clear, and criteria for evaluating success in these activities are often ambiguous.

 

    In regard to the trends in manager’s compensation schemes, I would like also mention changes in external environment: increasing importance of  institutional investors, global competition, creating knowledge economy, global presence of informational technologies, etc. These changes lead to shifts in internal and external power configurations, and as a consequence, redesigning the whole system of  job compensation, could it be salary, health insurance, or retirement benefits.

 

3. Overview of manager’s compensation schemes.  

 

Formal bonus or incentive plans are common and popular and most effective [7]. These plans are typically available for upper management employees although participation in the plans is widening, especially as organizations remove layers of management (Phase 5, [5]). The target formal bonus award is about 25-50% of the managers' base salary.  The size of the award is usually based on a combination of the participant's individual job performance, the business performance of the participant's division or department, and/or the performance of the entire company. Typical performance criteria includes profit before tax or operating profit, sales level or sales growth, and/or the achievement of specific company or division goals. 

 

Profit sharing plans are funded by the organization's profits based on a specified formula. The profit sharing pool is then allocated to managers as a percentage of their base salary, typically 5-6%. Currently approximately 40% of companies offer profit sharing plans. A typical profit sharing award is 5% to 6% of manager's base salary.

 

Spot bonuses (a) and Lump sum merit awards (b), perks  provide recognition for an individual's work accomplishments, which are paid immediately after a significant job performance event (a) or as a part of the annual salary review process (b).

 

 Stock plans are very popular. A mystique surrounds them, perhaps because a few people have gotten rich from stock options.[7] Virtually all companies offer some type of stock plan to employees.

 

      Stock option plan  is a most common form of stock plan. Manager is offered a specific number of shares which he can exercise (buy) at some specified time in the future. The price at which he can buy the stock is equal to the market price at the time the stock option was granted (grant price). The employee's gain is equal to the market value of the stock at the time it is exercised, less the grant price. If the market price of the stock remains the same or decreases relative to the grant price, then the stock option is worthless.

   Stock options provide companies with a long term incentive and retention tool. The recipients of stock options are motivated to help the company perform well, so the stock will appreciate in value. Because they must wait several years to receive the entire stock option grant, managers are motivated to remain with the company, as long as the stock value is increasing.

 

     Employee stock purchase plan is typically available to all managers in the company. They can purchase company stock through payroll deductions (typically up to 10% of pay) at a price that is below the market price (typically 85% of market price).

 

  Pension plans, Health and welfare plans offered to all fulltime[2] employees and typically cost organizations 12% to 15% of payroll. 

 

Variable compensation is based on the number of specified skills, qualifications or tasks manager has mastered.

 

4. Trends in manager’s compensation schemes.

 

    Over the period 1997 to 2002, total manager’s compensation increased by 15 percent.  The most recent findings have revealed the trend towards higher salaries for top executives. [8]  The recession is claimed to be the reason for  mass loss at stock options, burned by the market; managers aren't accepting the changes without protest,  beginning to demand more tangible rewards such as cash, bigger bonuses and material perks to offset the risk of options [9]. So, trends in management compensation can investigated in two dimensions: cash and non-cash.

 

4.1. Non-cash, or stock compensation schemes.

 

    Stock options were practically irrelevant during 60s and 70s, when share appreciation was almost null. Managers with worthless options laughingly called them “wallpaper.” The situation began to change with the emergence of the computer industry.  Managers  took big options grants in lieu of big salaries when they joined IT start-ups such as Oracle Corp., Sun Microsystems, Microsoft. When the companies went public, “the computer prodigies who had cast their lots with them were rich - and the stock option's central place in the industry was cemented.” [8]

   For companies, options grants are free money, because in their accounting treatment they are doubly blessed: They aren't declared as a cost on corporate earnings statements, yet they are deductible as a cost for the purpose of taxes.

     Of course, there is no “free lunch” and  not every manager can pretend to have stock options.  For example, about 30% of Microsoft Corp.'s work force is classified as “temporary,” ( not fulltime) and thus ineligible for stock options - even though one may work, say as program manager,  at the software giant for years. 

   

    Many companies are finding today,  that a regular options program isn't enough to retain the best managers and are turning to “special stock options”. The term refers to extra options, often called chairman's awards, that companies grant to certain standout managers whose compensation packages already include stock options. This isn't a case of just raising an employee's regular grant under a company's options program. These are special one-time awards of options to reward specific achievements by an employee or to retain a valuable manager who is at risk of leaving. Sometimes these additional options even have longer vesting periods (the length of time before they can be exercised) in order to further entice manager to stay.  That's because many companies are under intense pressure to provide incentives to key managers- such as information-technology staff and development engineers- who are getting bombarded with job offers. Some compensation experts say they're now advising companies to set aside as much as 5% to 10% of their stock-option pool for such special bonuses.[7]

 

   To maximize their retention power, companies might award a special grant of options for, say, 100 to 2,000 shares. And they might be fully exercisable after five years, compared with the typical three-year or four-year vesting period of regular stock options. Some companies have created special bonus programs for employees considered high-risk or particularly valuable. Under such a program, a company might from time to time award special options or restricted stock to  key managers who have the potential to move up the ladder.

   For example, American Express Co. counts its special-options program as one of its successful initiatives. Each year,  company awards regular stock options to middle and senior managers based on a list of criteria, such as an individual's contribution and the company's overall performance. In addition, “we have the flexibility to award special grants, if we believe that awarding options to attract and retain key talent would be helpful, we can do that.” [10]

 

    Typically, companies are very quiet about awarding such special bonuses to avoid creating envy among co-workers. Whereas all employees would be aware that coworkers receive options under a company's regular option program, they wouldn't necessarily know when one manager is singled out for a grant of special options.

 

      The recent recession, however,  created necessity to go back to cash compensation: with decreasing of  P/E ratios from infinity (for internet companies) to, say 10,  options are going to look less valuable.

 

4.2. Cash compensation schemes.

 


    For the first time since 1985, there has been an overall decrease in the benchmark salary paid for managers virtually in all industries. Senior staff levels have some good news; base salary has inched up while total compensation has gone down. As the economy worsens, mid-sized organizations are effected more and thus are cutting costs and staff faster. “Many larger organizations have put hiring freezes in to effect as well as stretching out the time period between normal compensation increases. In the past six months there has been a significant "thinning" of the layers within many organizations.” [11]. The chart below shows the seven year historical trend of the benchmark ranges for the different management positions in US organizations. [11]

 

In post interviews, Janco found reduced corporate earnings, which make up key components of most performance bonus plans, have driven the trend to lower total compensation. There has been a decrease in demand for IT professionals due to extensive across the board head count reductions. In addition as more companies have closed their doors, the surplus supply of senior level IT professionals has exploded. A factor not fully reflected in the study is the delayed effect of 9/11 and the move away from concentrated metro areas for some IT and back office operations.

There are some bright spots. The good news is that over-all productivity is up in IT organization and demand is high for Disaster Recovery and Security job titles.

Most of the decrease is based on reductions in performance bonuses for the most senior positions..

Biotechnology companies are also increasing their use of vari-able compensation, as a means of attracting quality candi-dates and managing their compensation budgets. Variablecompensation is normally closely tied to achievement or over-achievement of specific corporate goals and objectives. Ifthese objectives are not met, there is usually no payout to theindividual.Variable compensation, traditionally only available to manage-ment or sales positions, is now potentially a component of allpositions in an organization. However, the percentage of vari-able compensation in total compensation packages variesgreatly among positions:· Senior management and sales positions commonly have35 - 50% variable compensation in their total compensationpackage· Technical positions have approximately 10 - 15%variable compensation· Administrative or support positions have less than 5%variable compensationTotal Cash Compensation levels being paid to key biotechnol-ogy positions should be monitored as an indicator of the stateof the biotechnology industry. Competition from the pharma-ceutical industry is a key factor driving many biotechnologycompensation levels. Compensation data for 2000/2001reports the following average total cash compensation* paidout to a selection of biotechnology positions:·Sr. Manufacturing Executive$133,700·National Sales Manager$121,700·Business Development Director$111,500·Regulatory Affairs Director$101,300·R&D Manager$98,200·Intellectual Property Manager$92,500·Sr. Research Scientist$78,900·Sr. Clinical Research Associate$70,500·Bioinformatics Software Engineer $65,900*All figures national industry averages in Canadian dollarsand do not include stock options.



  

 

 

 

As we move from the economic downturn of 2000- 2001, into a new year, uncertainty about the magnitude and speed of a business recovery still prevails. We don't have a crystal ball, but we are in the market everyday, talking to business and IT leaders like yourselves.

 

 

 

 

 

 

 

 

 

Sources.

1.      David B. Balkin “New Perspectives on Compensation”

2.      Derek Torrington “Personnel Management”

3.      Richard M.Steers “Strategic Issues in Executive Compensation Decisions”

4.      John R. Deckop “The Pay-for-Performance Issue”.   

5.      Larry E. Greiner “Evolution as Organizations Grow”

6.      Henry Mintzberg “The Organization as Political Arena”

7.      American Compensation Association  www.worldatwork.org

8.      www.forbes.com/investing/personal finance.

9.      www.CareerJournal.com

10.  www.americanexpress.com

11.  www.e-janco.com/index.htm

12.  www.imercer.com

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[1] I regard an expert as a manager , because he makes decision, concerned with management: leading a project, managing knowledge base. Word “line” shows difference in working place. 

[2]It will be discussed later, why the word “fulltime” is important.


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