Designing a Compensation System

An employee’s paycheck is certainly important for its purchasing power. In most societies, however, a person’s earnings also serve as an indicator of power and prestige and are tied to feelings of self-worth. In other words, compensation affects a person economically, sociologically, and psychologically.10 For this reason, mishandling compensation issues is likely to have a strong negative impact on employees and, ultimately, on the firm’s performance.11

The wide variety of pay policies and procedures presents managers with a two-pronged challenge: to design a compensation system that (1) enables the firm to achieve its strategic objectives and (2) is molded to the firm’s unique characteristics and environment. ...

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