Chapter 18: Supervisory and Managerial Compensation

Overview: This chapter looks at the role of managers within the organization and the kinds of compensation programs, combining base pay and incentive pay, that are used to motivate and reward this important group of employees.

INTRODUCTION

Managerial employees represent the most common group to be identified as requiring special compensation programs. This is for a number of reasons.

1. Managers are a small part of the total number of employees in any organization but represent a disproportionately high percentage of total wage costs.
2. They are a group of vital importance to the operation of the organization, and it is essential to individualize compensation for each manager.
3. It is possible to develop measures of individual performance such that incentives are appropriate and desirable, since it is of utmost importance that managers associate themselves with organizational success.

Within the management group (for our definition) there is the "executive group". Common to many position naming systems, these positions carry the lead title "Top", or Vice President (except in financial institutions), "Chief", or other nomenclature that differentiates their position within an organization hierarchy. In many international locations and within smaller-to medium-sized North American firms, the terms manager and executive are interchangeable. This is not the case for large U.S. publicly traded corporations, and it is clearly not the case for the compensation levels and practices paid and used. "Executive compensation" is a subject on its own, and for this reason will be dealt with separately in the next chapter (chapter 19).

The focus of this chapter is on the group of managers that falls between these top executives and the non-supervisory employees. It extends from first-line supervisors up to high-level middle managers. They are the "in between" employees who translate the strategies of top management into daily operations. They need to understand and be able to deal with the two groups above and below them effectively if the organization is to prosper.

MANAGERS: THE JOB AND THE PERSON

As a beginning point we will examine the nature of the managerial job and the characteristics of the people who occupy this role in organizations.

The Managerial Job

Presthus identified one of the basic patterns by which people accommodate themselves to working in organizations to be that of being upwardly mobile. People like this accommodate to organizational life by associating their goals with those of the organization.¹ The major group of people in organizations who meet this description are its managers. This connection that these people make between themselves and the organization needs to be enhanced and encouraged through the compensation plan. This section will discuss the managerial role, the characteristics of managerial work, and the differences in levels of managerial work.

The Managerial Role. In a way all managers are like what has been said of foremen, they are the people in the middle.² This emphasizes the fact that managers have to please a number of constituencies in order to get their work done. Broadly speaking, managers have an internal role and an external role.³ The internal role has to do with directing an organizational unit. In interpersonal terms, Katz sees this as a leadership function.⁴ The external role requires the manager to deal with people outside the organizational unit to accomplish the unit's work. This role is not as clearly defined as the internal role but involves developing relationships, gathering information, and deciding where the organization is going and how to get there. In this, the manager is often like the salesperson--on the margin of the organization. To the extent that this is the case, variable pay plans would seem appropriate.

Mintzberg has elaborated further upon the roles of a manager.⁵ He has developed ten roles, divided into three categories--interpersonal roles, informational roles, and decisional roles. Each of these categories has roles that can be considered internally and externally oriented, as illustrated in figure 18-1. Externally, the manager represents the organization to the world, deals with the world, and decides the direction the organization or the unit needs to take. Internally, the manager directs organizational activity and allocates resources to accomplish goals. All this is central to the organization's success. Not all managerial jobs contain all ten roles equally, nor do all managers perform all roles equally. This leads to a great deal of variety in the definition of the managerial job, with the manager having a good deal of influence over their definition.

Characteristics of Managerial Work. Mintzberg goes on to point out that managerial activity has three basic characteristics: brevity, variety, and fragmentation. Managers deal with a great many things each day - sometimes a hundred or more - and these cover a wide variety of topics. Managers are active people. They perform a large quantity of work and find it hard to leave it behind when they leave the office. In this they are like professionals. Further, managers are not able to concentrate their energies on a single project until it is completed; instead they jump from one thing to another all day long, leading to a feeling of fragmentation. This makes the job very ambiguous to the manager.

It is no wonder that Sayles finds that managers have a hard time describing to others what they do in meaningful terms, and what comes out sounds like a lot of little unconnected items.⁶ Thus, describing the managerial job can be very difficult, partly because the manager has trouble defining what he or she does and partly because it is hard for others to make sense of what is done. Developing useful job descriptions is difficult in this circumstance. Since most compensation programs need job descriptions for evaluation purposes, this problem may change the way managerial compensation is handled. Since managerial jobs differ in the degree to which certain activities take place in the job, the characteristics also vary. For instance, managerial jobs such as sales or marketing positions are more subject to brevity and fragmentation than some other managerial jobs.⁷

Levels of Managerial Work. Organizations are hierarchical, which is what creates the managerial role in the first place. Large organizations have a number of managerial levels. In fact, the organization chart is usually a chart of the managerial jobs in the organization. Compensation plans for the managers in an organization generally follow this organizational hierarchy closely. The hierarchy contains three levels of managers: top management (executives), middle management, and lower management (supervisors). The latter two will be discussed here.

Lower Management. At the bottom of the hierarchy are the supervisors. They are first-line managers. That is, they direct the work of non-managerial employees. This job is more internally oriented, in two ways. First, the supervisor is more intimately concerned with a small group of workers and the work of that unit. Second, although the supervisor's external contacts are outside the organizational unit, they are usually still within the organization itself. The pressures of the first-line supervisor are immediate and influence today's results, in considerable contrast with the top manager, who is concerned mostly with problems extending years into the future. Because supervisors are so close to their workers, the job comparison standard for first-line supervisors is often the worker in the organizational unit. Thus, the supervisor's wages are some percentage over those of the workers. In fact, a series of studies shows that employees have a definite idea about the "appropriate" distance between organizational levels. Mahoney's review of these concepts and studies indicates that about a 33 percent distance between organizational levels feels right to people.⁸ A study by one of the authors shows a lower differential at the supervisory level, closer to 20 percent.⁹

Middle Management. As the name implies, this consists of the organizational levels between the supervisor and top management. These managers manage other managers and act as an information channel between top management and supervisors. Their perspective is ordinarily intermediate. They are usually responsible for a specific function in the organization and spend much of their time coordinating this function with other groups in the organization. A great number of the contacts of this group are lateral, so that getting work done is through means other than the use of authority.¹⁰ This creates considerable ambiguity for the middle manager, a feeling that he or she is responsible but does not have the necessary control. These contacts make peer comparisons important for this group. Compensation for this group is often related to the function that is being managed, and since there are large enough numbers of managers, managerial wage surveys make sense. It should be noted that this group has been reduced in numbers dramatically in the past twenty years as organizations have downsized and eliminated organizational levels to reduce bureaucracy.

Managers

It is difficult to identify any particular personality pattern as being common to managers. However, there are a number of characteristics of managers that are relevant to the development of a compensation program for them that need to be explored. These are their commitment, decision orientation, and power needs.

Commitment. From the discussion thus far, it should be clear that commitment is one thing managers have and organizations need. Managers associate themselves with the organization and spend a great deal of time at their work, usually up to 60 hours a week. But even if they are not formally working, managers find it is hard to turn off the job. They think about their job even when they are supposed to be at leisure. In terms of the membership model, these people have high inputs and will therefore expect high outcomes from the organization.

Decision Orientation. Managers are action oriented. Mintzberg found that managers had a preference for live action and the use of verbal media.¹¹ This often gives them the appearance of being intuitive rather than analytical in their decision making. This is in contrast with the reasons why the professional, who is analytical, is valuable to the organization. The manager ensures that things keep moving and get done. Decisions are the heart of the manager's job.¹² In a way, this is what managers are paid for. Certainly the time span of discretion, by which Jaques measures job level, implies that decisions are central to defining managerial jobs.¹³ Likewise, the Hay system of job evaluation, the one most commonly used to evaluate managerial jobs, focuses upon three aspects of decisions: know-how, problem solving, and accountability.¹⁴ So an orientation to decision making is probably useful in trying to evaluate managerial jobs and performance. Furthermore, both Kotter and Mintzberg find that being knowledgeable about the business and organization and having a wide set of contacts in order to collect information are important aspects of the manager's job.¹⁵

Managerial decision making is not like technical decision making. Katz points out that as managers move up the organizational hierarchy, they need to have higher levels of conceptual skill. This skill requires the manager to think in terms of general trends rather than specifics and to be able to see the forest for the trees.¹⁶ This skill may be related to the idea of left-brain thinking.¹⁷ The point is that managers, as they move up in the organization, need to be able to think and make decisions using a much broader framework and be able to deal with high levels of uncertainty. These skills may be in very short supply within the society, creating demand higher than supply.¹⁸

Power Needs. McClelland found that, unlike sales personnel, managers do not have a high achievement drive. This is not to say that they do not focus on accomplishing things or are not ambitious; they do and are.¹⁹ But they do not match McClelland’s technical definition of achievement drive. What McClelland did find out about managers is that they have high power needs.²⁰ They enjoy controlling a situation and having a strong influence on the outcome of events. This desire for power can take two different forms, power over and power to. The former is a personal definition of power that taps the unsavory aspects of the idea of power. The power to is a more institutional expression of power that focuses on getting the job done in the organization within the rules of the organization. Compensation programs for managers need to encourage this latter type of power drive.

This power aspect of the manager indicates that managers have and need considerable interpersonal skill. Most studies show that this is true. Katz sees that this interpersonal skill takes on two forms, supervisory and peer. Supervisory skill has to do with the leadership of the people in the manager's organizational unit. Peer skill has to do with the myriad contacts the manager must engage in outside the organizational unit in order to get the work done.²¹ Also connected to power is the idea of status. Managers spend a great deal of time on the job, are committed to the organization, and carry heavy responsibility. They must find it worth doing. Beyond the high wages there are a number of other extrinsic and intrinsic rewards available to managers. The management job is held in esteem within the organization, if not in society as a whole. But there is a hierarchy of managers in the organization, with those further up having more status than those lower down. The measure of status is most often reflected in the wages of the person. Thus, managerial compensation is a reflection not only of job worth but of the rank and status of the manager.

MANAGERIAL COMPENSATION SYSTEMS

Managerial compensation programs can be analyzed using the same categories as we have for other compensation programs but at times are administered differently. So, this section examines managerial compensation in these categories:

• Wage Level
• Base Pay
• Variable Pay
• Benefits

The Wage Level

The managerial group in the organization has a number of characteristics that affect the pay level decision in the direction of paying this group at or preferably above market. First, this group of jobs is very important to the organization. The people in these jobs are highly skilled and replacement can be difficult. These factors would call for a wage level decision that emphasizes being at or above market in order to be able to recruit and retain these employees. Tied to these factors is a second consideration, the sunk costs that the organization has in the manager. Ordinarily, the manager is a person who has worked for the organization for a number of years, and the odds are good that the organization has spent considerable money in training this person as he or she has moved up the managerial ranks.

A third consideration that supports a high wage level decision is that this is a small group of employees. So even if wages are high for the group, their overall impact on total wage costs of the organization may be small. Fourth, managers are in contact with the outside world a great deal. This means that they are more likely to be aware of the market rates for their jobs than other employee groups and that they are visible to other organizations that would be inclined to make an employment offer to them. Any group that is both important and visible, as is this group, will have to be paid competitively in order to hold down turnover. A final consideration that calls for an aggressive pay level decision is the relatively small supply of managers as compared with other employee groups. There is evidence that although a large number of students are going on to college and obtaining degrees, many do not desire managerial positions as much as professional ones.²²

Middle management pay criteria are more likely to be influenced by internal organizational factors, particularly the organization chart and the salary of the top executives. The organization chart becomes a guide for determining the appropriate internal references - those at the same organizational level. The top executive's pay becomes a ceiling in the organization: all other managerial positions can be measured in terms of their percentage of that person's pay. This is a common way in which middle management pay is reported.

On the other hand, pay levels for supervisory and the lowest managerial levels tend to be set as a percentage above those of the employees being supervised.²⁴ This percentage increases with each level. Supervisors earn 13% more than team leaders, second level supervisors earn 59% more than supervisors and third level managers earn 73% more than second level. This differential is supposed to reflect the complexity of the managerial task. Organizations can use both the top-down and bottom-up approaches, but they may find that there is a compression problem, or the opposite, a gap in the middle grade levels. This is because the starting points at the top and at the bottom are using different criteria, so where the results of these calculations come together, there can be either a gap or an overlap.

These various criteria used for managerial jobs should not be interpreted to mean that market rates for managerial jobs cannot be obtained. In fact, there are many managerial wage surveys. These can be both general managerial surveys and industry-specific surveys. Examples of the major general surveys are listed in figure 18-3. Most industries, through their associations, also conduct and distribute managerial wage surveys. The advantage of these industry surveys is that they provide information on jobs that reflects the way organizations in the industry organize. For instance, the banking surveys provide information on jobs such as loan officer and branch manager. Often these surveys will provide information on wages for the overall sample and use major breakdowns, such as geographical regions and size of organization. A problem with some of these data is the sample size. Since usually there is only one position for a particular job title per organization, if the sample is subdivided, the number of positions included can become quite small and the data not as usable. The most comprehensive data on executive salaries can be found in ERI's Executive Compensation Assessor.

Base Pay

The base pay of managers can represent as much as two thirds of their total compensation or as little as one third, with some executives. This percentage tends to vary with organization level; the higher the level, the lower the percentage of total pay represented by base pay. Generally, the base pay of managers is set using the model developed in this book. However, there are some special considerations for management pay which will be examined here.

A Managerial Wage Structure? The first consideration is the question of whether to use the general wage structure or to develop a separate managerial wage structure. Many organizations do have a separate wage structure for managerial employees. Some of these structures include more than just managers: they include other groups, particularly professionals. These wage structures often include all exempt employees. The main rationale for this separation of wage structures is that the pay-policy lines for exempt and nonexempt are so different that combining them leads to a false straight-line function, the relationship between market wages and the job evaluation system being curvilinear in this case.

As indicated, managerial jobs tend to be difficult to describe, and thus, although job descriptions are used for managers, they often are not taken as seriously in determining wages. Management job descriptions are typically written in terms of broad functions, areas of responsibility, scope and impact of assignments, degree of accountability, and the extent and nature of supervision and influence involved. This is in contrast with the focus on tasks and activities performed in a standard job description. Since there is only one job incumbent in most managerial jobs, each job is unique, and the impact of the manager on the nature of the job can be great. Properly developed managerial job descriptions are useful for organizational and personnel planning as much as they are for compensation.

In the 1950's, organizations often had a different job evaluation plan for management. This was probably useful only in large organizations, given the cost of developing a separate system. Most organizations today utilize a rank-to-market plan (benchmark ranking), wherein the organization compares its jobs with one or more compensation surveys to determine if there is a good match. In this type of plan the structure is designed first and then jobs slotted into appropriate ranges depending upon their market value.

The wage structure for managerial jobs is characterized by wide ranges and broad grades. Ranges may be typically 50 to 60 percent wide, but 100 per cent is also quite common. The arguments for this are (1) that the evaluation of managerial jobs is not as precise as it is for lower-level jobs and thus a broader range allows for variation, and (2) that there is more possible variation in performance of managerial jobs, so the use of wider ranges allows the organization to recognize this greater variation. Grades and ranges are more likely to be seen as guidelines in managerial compensation rather than as strict rules. The midpoint is important since it reflects the labor-market value. Minimums are less likely to be used, since rarely would a person who is minimally qualified be placed in the job. Maximums are not held to because the performance or value of a particular manager supersedes and exceeds the structure.

Pay Increases. The basis for managerial pay increases is most often some definition of individual performance and is determined by a management by objectives (MBO) program. Measurable standards are developed by the manager and his or her supervisors. At the end of the time period, performance is evaluated by both parties in a joint meeting in terms of how well the objectives were met. This system can work well where each party respects the other and does not play power games with the setting and evaluation of objectives. There are two main problems in MBO from the standpoint of tying it into wage increases. The first is that there is not much comparability between individuals so judgments about how much one person should receive versus another are not clear. The second is that the world may be too dynamic to set objectives and have them portend anything in a month, much less six months. Thus, MBO may be restrictive and hold managers to objectives that are out of date.

Two concerns with pay for performance for managers are (1) is pay contingent on performance and, (2) does it make any difference in performance when pay and performance are connected? Lawler found almost no relation between pay and performance measures on a sample of 600 middle- and lower-level managers. However, those managers that were most highly motivated did exhibit two crucial attitudes. First, they felt that pay was important to them (the first condition in the performance-motivation model). Second, they did feel that good performance would lead to higher pay. So, the perception is more important than the fact. Lawler went on to explain why it is hard for managers to always see the performance-reward connection. First, many of the rewards are deferred, so that the time frame is too long. Second, the goals are not always clearly expressed, so the manager does not know what he or she or the organization needs to achieve. Third, the secrecy that surrounds pay increases reduces the knowledge that the individual manager has as to how he or she has done comparatively.²⁵

The answer to the second concern may not be any more positive. In one of the few studies that examined an organization throughout a period of time in which a merit-pay system was installed, it was found that the system had no effect at all on organizational performance.²⁶ Although there may be a number of explanations for these results, the fact is that we cannot take it for granted that paying for performance is worth doing.

Variable Pay

Everything discussed so far has indicated that managers have more-than-average ability to affect their performance. Further, there are measures that can be used to determine this impact on the job. Therefore, variable pay would seem to be highly appropriate for managerial positions. Most organizations indeed claim that they pay managers in terms of performance, both that of the individual and that of the organization. If there is a difference between variable pay systems for managers and those for non-managers, it lies in defining performance in organizational and not personal terms. This difference increases as the job moves toward the top of the organization. This emphasis on organizational measures of success is functional since managers feel that organizational success is their success. But as in most variable pay systems, the correct performance standards must be the focus of the system. Schuster found that those managerial pay systems that were ineffective were those that did not focus on critical organizational outcomes.²⁷

Short-Term Incentives. Base pay may represent almost all of total pay for lower-level managers to as little as a third of top middle managers' total pay. The difference is made up in incentive bonuses, associated with both short-term and long-term performance. This section discusses short-term managerial bonuses.

The use of bonuses varies greatly with industry, but more than 50 percent of organizations have some sort of managerial bonus plan.²⁸ Those organizations with bonus plans tend to pay somewhat less in base pay than those without them. Bonus plans can be divided into immediate-cash plans and deferred plans. Since short-term plans are usually immediate-cash plans, they are covered here, and the deferred plans under the long-term plans are discussed in the next section.

Bonus Standards. The manager who receives a bonus receives it because some standard was met during the past time period, typically a year. As indicated, in pay for performance this standard may be either organizational or job-related. It is common for at least a portion of this bonus be based upon an organizational standard, like profits or cost reduction. But there are a number of other possible organizational measures, such as sales, productivity, or cost savings of one sort or another. Individual job-related standards may relate to job outcomes or to the performance of particular activities beyond minimum expectations. In addition, there is often a component of the quality of the manager's relationships with his/her subordinates. This is often measured by turnover in the organizational unit.

Bonus standards may be either single or multiple. Profit sharing is a single standard. Organizations may choose to focus managers on a number of variables that they feel are important measures of success. These may include combining organizational and job measures. Each variable must be weighted when multiple criteria are used. The problems with multiple plans are that they are more complex and therefore not as understandable, and the manager may have a hard time knowing what he or she will receive, since the factors may overlap or cancel each other out.

Bonus Formula. Most managerial short-term bonuses are established on the basis of a formula that operates at given levels of performance. It is possible, however, to establish a totally discretionary plan in which top management determines each year whether a bonus will be given for the past year's performance, and if so, how much. The arbitrary nature of this procedure and the lack of knowledge by managers of the effect of their actions ahead of time makes the incentive value of a discretionary plan low.

Ordinarily, a managerial bonus is based upon the base pay of the manager. When profit sharing is used, a percentage of total profits is placed in a fund, and each manager shares in the fund in the proportion of total managerial base pay represented by his or her base pay. When other measures are used, goals are established for each of the appropriate measures. If the organization achieves or exceeds the goal, the managers would receive a percentage of their base pay. For instance, assume that the organization wished to maintain a minimum return on assets of 10 percent. The managers may receive 20 percent of base pay if the organization achieves a 10 percent return on assets and an additional 5 percent of base pay for each 5 percent increase in return on assets over 10 percent. These calculations could be made for one measure or for a number of measures. Further, the measures could be independent, or any bonus at all could depend upon maintaining a minimum level of performance on all measures. Often limits are placed on the percentage above base pay that can be earned, such as 50 percent.

Eligibility. Bonus plans are usually based on a formula designed to reflect the participant's contribution to profits or other organizational measures of success. The motivational value of the plan depends in large part on whether the manager's actions do have an impact on these measures. The closer to top management, the more likely the manager is to meet these requirements, and thus such incentive plans would seem ideal for this group.

The lower the level of middle management, the less clear is the connection, but the possibility of earning a substantial amount over base pay may keep these managers' attention on and increase their interest in the organization's goals. For lower-level management, the case for incentives tied to organizational performance is hard to make. The amounts these managers typically receive are small and the connection of their actions to the performance standard nonexistent. Variable pay plans for lower-level managers should be based more upon establishing job-related measures of performance that the organization believes will also relate to organizational success.

Long-Term Incentives. The argument for long-term variable pay plans for managers becomes much stronger the further up the organizational chart one goes. The purpose of long-term incentives is to tie the manager into the long-term success of the organization. These plans usually involve the granting of rights to the manager to become a stockholder of the organization at a reasonable cost today so that if the organization does well in the future, the stock will be of significant value. Plans associated with long-term incentives are discussed in depth in the next chapter (19).

Benefits and Perquisites

Managers are often granted additional benefits. The rationale for additional benefits is that retention of this group of employees is very important to the organization, so enhancing the membership decision is an important compensation goal. These additional benefits are often termed golden handcuffs. Some of these extra benefits are increases in the benefits available to all employees and some are special benefits for just the management group called perquisites.

Managerial Benefits. Retirement benefits of managers tend to be the maximum available within the organization's plan since managers are usually the highest-paid employees and have long service - the two criteria that determine benefit levels. In addition, long-range incentives also provide the manager with a source of retirement income.

Insurance coverage for managers is high since, again, the criterion is most often salary. Top executives are often given additional life insurance and special types of insurance, such as travel insurance. Although their time off provisions are the same or higher, managers tend not to take advantage of them as readily as other groups. It is sometimes necessary to insist that managers take the time off that is available to them, both because they need that time off and because a large liability can be created for the organization if a category such as vacations is allowed to accumulate.

Managerial Perquisites. This is a set of special benefits available to managers, primarily top managers, which are designed to satisfy the special needs of this group. There are a number of perquisites. The first category is internal. These perquisites consist of items that are part of the work setting of the manager, such as special offices and furniture that distinguishes the status of the manager. A second category, external perquisites, has to do with conducting business outside the organization, such as a car, entertainment expenses, and club memberships. The last category is personal perquisites. This category consists of a wide variety of items, such as free medical examinations, low-cost loans, and financial or legal counseling. The last group is distinguished from the first two in that it is usually taxable to the employee.

SUMMARY

Managers are probably the most important group of employees in the organization. While they represent a small percentage of the workers, they represent a major portion of the cost of compensation. It is important to develop a compensation program for this group that both obtains the most from these employees and keeps the costs within reason. The managerial job is one of high stress, a great deal of variety, and the need to exercise considerable judgment. Managers are highly committed to the organization, have an action orientation, and a need to express their power motive.

Compensation programs for managers are a combination of base pay and incentive pay. Given the importance of this group, its high visibility, and easy movement to other organizations, it is usual to use a high-paying wage level strategy for this group. Individual pay determination is most typically dominated by pay-for-performance with management by objectives used as a basis for measuring performance. All organizations have a keen interest in the rewards being earned by similar individuals in similar positions.

Managerial incentive programs are divided into short and long range. Short-term programs are typically rewards for performance in a particular year based on how well the manager did in achieving his or her goals but with a measure of overall organizational performance forming the base of the bonus pool from which these funds emanate. Long-term managerial incentives are intended to tie the executive into the organization, both so the executive will stay with the organization and continue to perform highly. Most of these plans are a variation of an equity plan that grants stock or money, based on overall organizational worth, to the executive over a long time period. These plans are typically deferred income. Managers are also granted a variety of benefits and perquisites that are not available to other employee groups.

Footnotes