CHAPTER 6 COMPENSATION

COMPENSATION
Because of high cost HR managers spend a great deal of time developing effective compensation and benefit programs for international employees. A survey by the conference board reported that an expatriate costs; 29% reported 22.9 times salary. 50% reported 33.9 times salary. 18% reported 44.9 times salary.

COMPENSATION
A recent report in Fortune on doing business in China, reported that hiring a local Chinese Manager with 15 years experience would cost less than US $70000; a US expatriate would cost US $300000.

COMPENSATION
For multinational firms, successful management of compensation and benefits requires: knowledge of the taxation laws, customs, environment, employment practices of many foreign countries, familiarity with currency fluctuations, the effect of inflation on compensation, understanding of why and when special allowances must be supplied and which allowances are necessary in what countries. shifting political, economic and social conditions.

Aims of compensation policy

The policy should be consistent with the over all strategy, structure, and business needs. Must be able to attract and retain staff. Should be able to facilitate transfer of international employees. Must take care of equity and ease of administration.

Expectations of employees
Financial protection in terms of benefits, social security, cost of living. Opportunities for financial advancement through savings. Issues such as housing, education, and recreation would be taken care. Career advancement opportunities.

OBJECTIVES OF INTERNATIONAL COMPENSATION

The expectations of both sides could create possible problems, since some of the objectives cannot be maximized and could lead to a complex situation. This is more so because three categories of employees are involved. Fundamentally there is not much difference in the expectations of both in formulating domestic compensation package.

Key components of international compensation

Base Salary Base salary is the foundation block for international compensation. Other benefits depend on the rate of base salary. It may be paid home or local currency. Major differences can occur depending upon whether the base salary is linked to home country, of PCN or TCN or whether an international rate is paid.

Key components of international compensation

Foreign Service Inducement / Hardship allowance PCNs often receive a salary premium as inducement or as compensation for any hardship caused. These are generally made in percentage of salary, usually 5 to 50 % of the base pay. Depending on; the assignment actual hardship tax consequences length of assignments host countrys work week

Key components of international compensation Allowances Cost of Living Allowance (COLA) It is important to note that these payments are more commonly paid to PCNs than TCNs. Cola receives most attention, involves a payment to compensate for the differences in expenditures between the home country and the foreign country (on account of inflation differentials). Often this allowance is difficult to determine, so companies may use the services of other organizations, such as Organization Resource Counselors, Inc. etc. COLA may also include payment for housing and utilities, personal income tax, or discretionary items.

Key components of international compensation

Allowances Housing Often paid on either an assessed or actual basis. Other alternatives include company provided housing, either mandatory or optional a fixed housing allowance, or assessment of a portion of income, out of which actual housing costs are paid.

Key components of international compensation

Allowances Other Housing Issues Companies usually pay a tax-equalized housing allowance in order to discourage the purchase of housing and/or to compensate for higher housing costs; this allowance is adjusted periodically, based on estimates of both local and foreign housing costs.

Key components of international compensation

Allowances Other Housing Issues Housing issues are often addressed on a case to case basis, but as firm internationalizes, formal policies become more necessary and efficient. Financial assistance and /or protection in connection with the sale or leasing of an expatriates former residence are offered by many multinationals. Those in the banking and financial industry tend to be more generous, offering assistance in sale or leasing, payment of closing costs, payment of leasing management fees, rent protection, and equity protection.

Key components of international compensation

Allowances Leave allowance To cover the expenses of one or more trips back to home country each year. The purpose of paying for such trips is to give expatriates the opportunity to review family and business ties, there by helping them to avoid adjustment problems when they are repatriated.

Key components of international compensation

Allowances Leave allowance Some firms give expatriates the option of applying the allowance to foreign travel rather than returning home. Firms allowing use of home leave allowance need to be aware that expatriates with limited international experience who opt for foreign travel rather than returning home may become home sick than the other expatriates who return home for a reality check with fellow employees and friends.

Key components of international compensation

Allowances Education allowance For expatriates children are also an integral part of any international compensation policy. The level of education provided for, the adequacy of local schools, and transportation of dependents who are being educated in other locations may present problems for the multinationals. PCNs and TCNs usually receive the same treatment concerning educational expenses. Attendance at a university may also be provided for when deemed necessary.

Key components of international compensation

Allowances Relocation allowance Usually cover moving, shipping and storage charges, temporary living expenses, subsidies regarding appliances or car purchase (or sales), and down payments or lease related charges. Allowances regarding perquisites (cars, club memberships, servants, etc) may also be needed to be considered (usually for more senior positions, but this varies according to location). These allowances are often contingent upon tax equalization policies and practices in both home and the host countries.

Key components of international compensation

Allowances Spouse assistance To help guard against or offset income lost by an expatriates spouse as a result of relocating abroad. Although some firms may pay up an allowance to make up for spouses loss income. US firms are beginning to focus on providing spouses with employment opportunities abroad, either by offering job search assistance or employment in the firms foreign unit (subject to work visa being available).

Key components of international compensation

Benefits There is inherent complexity in international benefits. Companies need to address many issues while considering benefits. Some of these are: Whether to maintain expatriates in home country programs, particularly if the firm does not receive any tax benefits for it. Whether firms have the option of enrolling expatriates in home country benefits and / or making up any differences in coverage. Whether expatriates should receive home-country or host country benefits.

Key components of international compensation

Benefits Most US PCNs typically remain under their home countrys benefits plan. In some countries, expatriates cannot opt out of local security programs; in such circumstances, the firm normally pays for these additional costs. European PCNs and TCNs enjoy portable social security benefits within European Union.

Key components of international compensation

Benefits Pension plans 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.

APPROACHES TO INTERNATIONAL COMPENSATION

There are two main options in the area of international compensation; Going rate approach (market rate approach) Balance rate approach (build up approach)

 Going rate approach Based on local market rates Relies on survey comparisons Local nationals (HCNs) Expatriates of same nationality Expatriates of all nationalities

APPROACHES TO INTERNATIONAL COMPENSATION

Compensation based on selected survey comparison Base pay and benefits may be supplemented by additional payments for low pay countries EG Japanese bank in NY would need to decide whether its reference point would be local US salaries, other Japanese competitors or all

APPROACHES TO INTERNATIONAL COMPENSATION-Going rate approach

Advantages Equality with local nationals Simplicity Identification with host country Equity amongst different nationals Disadvantages Variation between assignments for some employees Variation between expatriates of some nationality in different countries Potential re-entry problems

APPROACHES TO INTERNATIONAL COMPENSATION-Going rate approach

Survey by Towers Perrin of total compensation around the world COUNTRY US $ US Hong Kong Singapore France Britain Australia Switzerland Canada Germany Malaysia 901,181 672,877 572,414 523,511 489,710 476,700 465,180 440,886 423,898 342,151 CEO COMPENSATION IN

APPROACHES TO INTERNATIONAL COMPENSATION

The balance sheet approach The basic objective is to keep the expatriate whole. The foreign assignees should not suffer material loss due to their transfer

APPROACHES TO INTERNATIONAL COMPENSATION -The balance sheet approach

Principles Maintenance of home country living standard, plus financial inducement. 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.

 There are 4 major categories of outlays incurred by expatriates that are incorporated in the balance sheet approach. Goods and services---home country outlays for items such as food, personal care, clothing, house hold furnishings, recreation, transportation and medical care. Housing---major cost associated with housing in host country Income-taxes---parent country and host country income taxes Reserve---contributions to savings, payment for benefits, pension contributions, investments, education expenses, social security taxes, and so on

APPROACHES TO INTERNATIONAL COMPENSATION -The balance sheet approach

APPROACHES TO INTERNATIONAL COMPENSATION -The balance sheet approach

Expatriate Compensation Worksheet Employee Position Country Reason for change Effective date of change Brain Smith Marketing Manager New Euphoria New Assignment February 1998

APPROACHES TO INTERNATIONAL COMPENSATION -The balance sheet approach

Items Amounts A$ P.A. Paid in A$ P.A. Paid in local currency 1,01,250 50,625

Base salary 123,000 COLA 33,750 Overseas service premium(20%) 27,000 Hardship allowance(20%) 27,000 Housing deduction - 9,450 Tax deduction -51,079 TOTAL COLA Index = 150 162,221

67,500 27,000 27,000 - 9,450 -51,079 60,971

151,875

APPROACHES TO INTERNATIONAL COMPENSATION -The balance sheet approach

Advantages and disadvantages of the balance sheet approach. Advantages Disadvantages Equity -between assignments -between expatriates of same nationality Facilitates expatriate re-entry Easy to communicate to employees Can result in disparities -between expatriates of different nationalities -can be quite complex to administer

APPROACHES TO INTERNATIONAL COMPENSATION -Taxation

Taxation probably causes the most concern to HR practitioners and expatriates (both PCNs and TCNs) since it generally evokes emotional responses. To illustrate a potential problems, for US expatriate an assignment abroad can mean being double-taxed both in the country of assignment and in the US. This tax cost, combined with all other expatriate costs, makes some US multinationals think twice before making use of expatriates.

APPROACHES TO INTERNATIONAL COMPENSATION -Taxation

Multinationals generally select one of the following approaches to handle international taxation: Tax equalizationfirms withhold an amount equal to the home country tax obligation of the PCN, and pay all the taxes in the host country. It is far more common taxation practice used by multinationals. Thus for a PCN, tax payments equal to the liability of a home country tax payer with the same income and family status are imposed on the employees salary and bonus. The firm typically pays any additional premiums or allowances, tax free to the employee. As the multinationals operate in more and more countries, they are subject to widely discrepant income tax rates. It is important to note that just focusing on the income tax can be misleading because the shares of both social security contributions and consumption taxes are rising in the OECD countries. (org. for eco. dev. & coop.)

APPROACHES TO INTERNATIONAL COMPENSATION -Taxation

Tax protectionthe employee pays up to the

amount of taxes he or she would pay on compensation in the home country. In such a situation the employee is entitled to any windfall received if the total taxes are less in foreign country than in the home country.

APPROACHES TO INTERNATIONAL COMPENSATION -Taxation

Stuart adds two other approaches; Ad-hoc, each expatriate is handled differently, depending on the individual package agreed with the firm. Laissez faire employees are on their own in confirming to host country and home country taxation laws and practices. When multinationals plan compensation packages, they need to consider to what extent specific practices can be modified in each country to provide for the most tax-effective, appropriate rewards for PCNs, HCNs, and TCNs within the overall compensation policy of the firm.

APPROACHES TO INTERNATIONAL COMPENSATION -International living costs data.

Obtaining up-to-date information on international living costs is a constant issue for the multinationals. Many multinationals retain the services of consulting firms that may offer a broad range of services. A number of consulting firms offer regular surveys that calculate the COLA index and are updated in terms of currency exchange rates.

APPROACHES TO INTERNATIONAL COMPENSATION -International living costs data.

A recent survey of living costs in selected cities ranked 10 most expensive cities as; Tokyo Reykjavik (Iceland) Geneva Oslo Libreville (Gabon) Copenhagen Berlin Helsinki Stockholm and Munich.

APPROACHES TO INTERNATIONAL COMPENSATION -International living costs data.

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 basis of many complaints if updating substantially lags behind any rise in living costs.

APPROACHES TO INTERNATIONAL COMPENSATION -International living costs data.

Multinationals must also be able to respond to unexpected events, such as currency and stock market crash that suddenly unfolded in a number of Asian countries in late 1977. some countries, such as Indonesia, faced a devaluation of their currency by over 50% as against US $ in a matter of weeks, which had a dramatic impact on prices and cost of living.

APPROACHES TO INTERNATIONAL COMPENSATION -International living costs data.

The economist has developed its own bench mark of living costs based on the cost of a Mc Donalds Big Mac around the world. There are also considerable disparities in purchasing power around the world. The exhibit shows a range of data to illustrate this point with the purchasing power of working time shown for a range of factors. While the US workers do not have the highest hourly earnings, the purchasing power of the working time is high in terms of less working time required to pay for items such as petrol, income tax liability, consumer durables and food items.

APPROACHES TO INTERNATIONAL COMPENSATION -International living costs data.

A recent study by Economist Intelligence unit calculated an index that measures the relative cost of doing business in 27 economies by compiling statistics relating to wages, costs for expatriate staff, air travel and subsistence, corporate taxes, perceived corruption levels, office and industrial rents, and road transport. The top 10 most expensive countries in terms of business costs in 1997 were; 1. Germany 2. US 3. Belgium 4. Britain 5. France 6. The Netherlands 7. Sweden 8. Australia 9. Italy 10. Singapore

APPROACHES TO INTERNATIONAL COMPENSATION the purchasing power of working time.

Bread/ KG mins 6.5 6.5 5 3.5 18 Coffee/ KG h. Mins 2 11 47.5 20 36.5 4 15.5 Mens Shoes/pair H mins 4 10 3 45 2 38 4 56.5 10 8 Petrol / litre H mins 2.5 1.5 2 1 7.5 Rent 4 rms H mins 26 47.5 28 32 15 54 69 25.5 56.5 46 Color TV H mins 22 34 14 16 35 16 101 29 20 I-T P.A. H mins 265 30.5 481 135 129 95 3 42 24 11.5 Net earn / H.1995 $ US 12.53 16.73 27.06 18.2 6.17

Australia Canada Germany USA Korea

APPROACHES TO INTERNATIONAL COMPENSATION -International living costs data.

Germany is the most expensive country overall because of its very high basic wages, while the second most expensive rank for the US 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.

APPROACHES TO INTERNATIONAL COMPENSATION - Differentiating Between PCNs and TCNs

One of the outcomes of balance approach is to produce differentiation between expatriate employees of different nationalities because of the use of nationality to determine the relevant home country base salary. In effect, this is a differentiation between PCNs and TCNs. Many TCNs have great deal of international experience because they often from country to country in the employee of one multinational.

APPROACHES TO INTERNATIONAL COMPENSATION - Differentiating Between PCNs and TCNs

Reynolds has observed, that there is no doubt that paying TCNs according to their home country base salary can be less expensive than paying all expatriates on a PCN scale (particularly if the multinational is head quartered in a country such as US or Germany, which has both high managerial salaries and a strong currency), but justifying these differences can be very difficult. the reduction in expenses outweighs the difficulty of justifying any pay differentials.

APPROACHES TO INTERNATIONAL COMPENSATION - Differentiating Between PCNs and TCNs

However, as firms expand internationally, it is likely that TCN employees will become more valuable and firms may need to rethink their approach to compensating TCNs. As a starting point, multinationals need to match their compensation policies with the staffing policies and general HR philosophy.

APPROACHES TO INTERNATIONAL COMPENSATION - Differentiating Between PCNs and TCNs

If a firm has an ethnocentric staffing policy, its compensation policy should be one of keeping the expatriate whole (ie maintaining relativity to PCN colleagues plus compensating for the costs of international service).

APPROACHES TO INTERNATIONAL COMPENSATION - Differentiating Between PCNs and TCNs

If however staffing policy follows a geocentric approach (ie, staffing a position with the best person regardless of nationality) there may be no clear home for the TCN, and the firm will need to consider establishing a system of international base pay for key managers paid in a major reserved currency, such as US $ or Deutsche Mark. This allows the firm to deal with considerable variation in base salaries for managers.

APPROACHES TO INTERNATIONAL COMPENSATION - Differentiating Between PCNs and TCNs

Researchers have argued that The nationality or national systems thinking has had an excessive influence on managing compensation and reward systems internationally, and propose a strategic flexibility model, shown below. This model groups forms of total compensation into 3 sets: core, crafted and choice. Specific practices in the core section may vary according to the market and local conditions but must be consistent with the core policies.

Strategic Flexibility of International Compensation

Assignments CHOICE CUSTOMIZE Base/Bonus Mix CORE Competitive Cash Basic Benefits Performance Based Employability Work Based Stock Purchases

Flexible Schedules

Stock Options

Benefit Choices Tax Deferral Base / bonus Mix