IBUS 618 Dr. Yang1 Chapter 7 International Compensation.

IBUS 618 Dr. Yang 1

Chapter 7

International Compensation

IBUS 618 Dr. Yang 2

Chapter Objectives• In the introductory chapter we described IHR managers as

grappling with complex issues: Manage more activities from a broader perspective, Be more involved in the lives of their far-flung

employees Balance the needs of PCNs, HCNs and TCNs Control exposure to financial and political risks and Be increasingly aware of and responsive to host-country

and regional influences.

• In this chapter, all of these issues and concerns are brought out in a discussion of compensation issues. (cont.)

• In the introductory chapter we described IHR managers as grappling with complex issues: Manage more activities from a broader perspective, Be more involved in the lives of their far-flung

employees Balance the needs of PCNs, HCNs and TCNs Control exposure to financial and political risks and Be increasingly aware of and responsive to host-country

and regional influences.

• In this chapter, all of these issues and concerns are brought out in a discussion of compensation issues. (cont.)

IBUS 618 Dr. Yang 3

Chapter Objectives (cont.)

Examine the complexities that arise when firms move from compensation at the domestic level to compensation in an International context

Detail the key components of international compensation Outline the two main approaches to international compensation

and the advantages and disadvantages of each approach Examine the special problem areas of taxation, valid

international living cost data and the problem of managing TCN compensation

Examine the recent developments and global compensation issues.

Examine the complexities that arise when firms move from compensation at the domestic level to compensation in an International context

Detail the key components of international compensation Outline the two main approaches to international compensation

and the advantages and disadvantages of each approach Examine the special problem areas of taxation, valid

international living cost data and the problem of managing TCN compensation

Examine the recent developments and global compensation issues.

IBUS 618 Dr. Yang 4

Introduction Global compensation managers increasingly deal

with two areas of focus. They must manage highly complex and turbulent local

details, while Concurrently building and maintaining a unified,

strategic pattern of compensation policies, practices and values.

Domestically, such as in the U.S., how would you determine a compensation package? What factors to consider?

Internationally?

IBUS 618 Dr. Yang 5

IntrinsicIntrinsic

Participate in decision making

Greater job freedom and discretionMore responsibility

More interesting work

Opportunities for personal growth

Diversity of activities

Cost-of-living increase

Labor market adjustment

Time-in-rank increase

Profit sharing

Explicit Membership-

based

Protection programs

Pay for time not worked

Services and perquisites

Non-FinancialNon-Financial

Preferred office finishing

Preferred lunch hours

Assigned parking spaces

Preferred work assignments

Business Cards

Own secretary

Impressive titles

Employee Compensation

FinancialFinancial

ExtrinsicExtrinsic

Piecework

Commission

Incentive plans

Performance bonuses

Merit pay plans

Implied Membership-

based

Performance-based

IBUS 618 Dr. Yang 6

Per Capita Incomes by Metropolitan Area (U.S. Average: $29,469)

TOP 10

1 San Francisco, Ca $57,414 6West Palm Beach, Boca Raton, Fla

$41,007

2 San Jose, Ca $55,157 7 Trenton, NJ $40,954

3New Heaven, Bridgeport, Stamfort, Danbury, Waterbury, Conn.

$46,542 8Seattle, Bellevue, Everett, Wash

$40,686

4 Bergen, Passaic, NJ $42,726 9 Nassau, Suffolk, NY $40,353

5Middelsex, Sommerset, Hunterdon, NJ

$42,392 10 Naples, Fla $40,121

Source: U.S. Department of Commerce Bureau of Economic Analysis, The Mercury News, August 4, 2002

IBUS 618 Dr. Yang 7

Per Capita Incomes by Metropolitan Area (U.S. Average: $29,469)

BOTTOM 10

1McAllen, Edinburg, Mission, Texas

$13,344 6Auburn, Opelika, Ala.

$18,484

2Brownsville, Harlingen, San Benito, Texas

$14,906 7 El Paso, Texas $18,535

3 Laredo, Texas $15,114 8 Merced, CA $18,536

4 Yuma, Ariz. $16,002 9 Provo, Orem, Utah $19,128

5 Las Cruces, N.M. $17,321 10 Pine Bluff, Ark. $19,826

Source: U.S. Department of Commerce Bureau of Economic Analysis, The Mercury News, August 4, 2002

IBUS 618 Dr. Yang 8

Requirements for Successful International Compensation and Benefits

Knowledge of employment and taxation law, customs, environment and employment practices of many foreign countries

Familiarity with currency fluctuations and the effect of inflation on compensation, and

A good understanding of why and when special allowances must be supplied and which allowances are necessary in what countries

All within the context of shifting political, economic and social conditions.

All within the context of shifting political, economic and social conditions.

IBUS 618 Dr. Yang 9

Objectives of International Compensation

Should be consistent with the overall strategy, structure and business needs of the multinational.

Must be sufficient to attract and retain staff in the areas where the multinational has the greatest needs and opportunities, hence must be competitive and recognize factors such as incentive for foreign service, tax equalization and reimbursement for reasonable costs.

Should facilitate the transfer of international employees in the most cost-effective manner for the firm.

Must give due consideration to equity and ease of administration.

IBUS 618 Dr. Yang 10

Expatriate Expectations

Financial protection in terms of benefits, social security and living costs in the foreign location.

Opportunities for financial advancement through income and/or savings.

Issues such as housing, education of children and recreation to be addressed in the policy.

Career advancement and repatriation.


Key Components of International Compensation

The area of international compensation is complex, primarily because multinationals must cater to three categories of employees:

PCNs, TCNs and HCNs Key Components:

Base salaryForeign services inducementHardship premiumAllowancesBenefits

The area of international compensation is complex, primarily because multinationals must cater to three categories of employees:

PCNs, TCNs and HCNs Key Components:

Base salaryForeign services inducementHardship premiumAllowancesBenefits


Base Salary In a domestic context, base salary denotes the amount of cash

compensation serving as a benchmark for other compensation elements (such as bonuses and benefits).

For expatriates, many allowances are directly related to base salary (e.g. foreign service premium, cost-of-living allowance, housing allowance)

It is the basis for in-service benefits and pension contributions – may be paid in home or local-country currency.

The base salary is the foundation block for international compensation whether the employee is a PCN or TCN.

Major differences can occur in 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.


Foreign Service Inducement and Hardship Premium Parent-country nationals often receive a salary premium

as an inducement to accept a foreign assignment or as compensation for any hardship caused by the transfer. The definition of hardship, eligibility for the premium and amount

and timing of payment must be addressed. In cases in which hardship is determined, U.S. firms often refer

to the U.S. Department of State’s Hardship Post Differentials Guidelines to determine an appropriate level of payment.

Foreign service inducements are usually made in the form of a percentage of salary, 5-40% of base pay. Such payments vary, depending upon the assignment, actual

hardship, tax consequences and length of assignment.

More commonly paid to PCNs than to TCNs.


Allowances Multinationals generally pay allowances in order to

encourage employees to take international assignments and to keep employees ‘whole’ relative to home standards.

Establishing an overall compensation policy can be very challenging, partly because of the various forms of allowances, such as: Cost-of-living allowance Housing allowance Relocation allowance Education allowance Home leave allowance Hardship allowance


Cost-of-living Allowances (COLA) COLA receives the most attention, to compensate for

differences in expenditures between the home country and the foreign country (e.g., to account for inflation differentials, currency fluctuations, etc.).

COLA may also include payments for housing and utilities, personal income tax or discretionary items.

The provision of a housing allowance implies that employees should be entitled to maintain their home-country living standards (or, in some cases, receive accommodation that is equivalent to that provided for similar foreign employees and peers).

International comparison of cost of living is difficult and can be problematic.


Relocation Allowances Usually cover moving, shipping and storage charges,

temporary living expenses, subsidies regarding appliance or car purchases (or sales) and down payments or lease-related charges. Allowances regarding perquisites (cars, club memberships,

servants and so on) may also need 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 the home and the host countries.


Education Allowances

Expatriates’ children are an integral part of any international compensation policy. Allowances for education can cover items such

as tuition, language class tuition, enrolment fees, books and supplies, transportation, room and board and uniforms.

PCNs and TCNs usually receive the same treatment concerning educational expenses.


Allowances for Spouse Assistance

To help guard against or offset income lost by an expatriate’s spouse as a result of relocating abroad. Some firms may pay an allowance to make up for a

spouse’s lost income. U.S. firms are beginning to focus on providing

spouses with employment opportunities abroad, either by offering job-search assistance or employment in the firm’s foreign office (subject to a work visa being available).


Alternative Allowances

Housing alternatives may 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.

Home leave alternatives: Allow foreign travel rather than returning home Expatriates may become more homesick than others who

return home for a ‘reality check’ with fellow employees and friends.

As a firm internationalizes, formal policies become more necessary and efficient.


Benefits In addition to the already discussed benefits,

multinationals also provide vacations and special leave. 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, may provide the employee’s family with 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 or rest and rehabilitation periods.


Issues Concerning Benefits Very difficult to deal with country-to-country, as

national practices vary considerably: Transportability of pension plans Medical coverage Social security benefits

Firms need to address many issues, including: Whether or not to maintain expatriates in home-country benefit

programs, particularly if the firm does not receive a tax deduction for it.

Whether firms have the option of enrolling expatriates in host-country benefit programs and/or making up any difference in coverage.

Whether expatriates should receive home-country or host-country social security benefits.


Issues Concerning Benefits (cont.) Laws governing private benefit practices differ from

country to country, and firm practices also vary. In some countries, expatriates cannot opt out of

local social security programs. 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 have generally done a good job of planning for the retirement needs of their PCNs, but this is generally less the case for TCNs.


Going Rate Approach (also referred to as the Market Rate Approach)

Balance Sheet Approach (also known as the Build-up Approach).

Going Rate Approach (also referred to as the Market Rate Approach)

Balance Sheet Approach (also known as the Build-up Approach).

Approaches to International Compensation

There are two main options in the area of international compensation:There are two main options in the area of international compensation:


Going Rate Approach

Based on local market rates Relies on survey comparisons among

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.

Based on local market rates Relies on survey comparisons among

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.

Table7-1


Advantages and Disadvantages of the Going Rate Approach

Advantages Equity with local

nationals Simplicity Identification with

host country Equity among

different nationalities

Advantages Equity with local

nationals Simplicity Identification with

host country Equity among

different nationalities

Disadvantages Variation between

assignments for same employee

Variation between expatriates of same nationality in different countries

Potential re-entry problems

Disadvantages Variation between

assignments for same employee

Variation between expatriates of same nationality in different countries

Potential re-entry problems

Table7-2


The Balance Sheet Approach

The basic objective is to ‘keep the expatriate whole’ through maintenance of home-country living standard plus a financial inducement to make the package attractive. Home-country pay and benefits are the foundations of

this approach Adjustments to home package to balance additional

expenditure in host country Financial incentives (e.g., expatriate/hardship premium)

added to make the package attractive Most common system in usage by multinationals

Table7-3


Major Categories Incorporated in the Balance Sheet Approach

Goods and services Home-country outlays for items such as food, personal

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

Housing Major costs associated with housing in the host country.

Income taxes Parent-country and host-country income taxes.

Reserve Contributions to savings, payments for benefits, pension

contributions, investments, education expenses, social security taxes, etc.


A Typical Balance Sheet Additional Costs Paid by Company

Reserve Reserve Reserve Reserve

Goods and Services

Goods and

ServicesGoods and

Services

Housing

HousingHousing

HousingIncome Taxes Income Taxes

Premiums and Incentives

Host-Country Costs Paid by Company and

from Salary

Host-Country Costs

Home-Country Equivalent

Purchasing Power

Home-Country Salary

Income TaxesHome- and

Host-Country Income Taxes

Goods and Services


Table7-4 Expatriate compensation worksheet


Example of an Expatriate Compensation An expatriate working in a U.S. branch may

receive: Base pay: $1,750/mon Housing: up to $1,400/mon (Optional) Itemized reimbursement: $500/mon Discretionary expense (e.g., gifts & gratuity to

clients and partners): $1000/special holidays Benefits: Social security/Medicare (Optional) Health care: $200/mon matched by employer Unemployment coverage Workers comp


Advantages and disadvantages of the Balance Sheet Approach

Advantages: Equity

Between assignments

Between expatriates of the same nationality

Facilitate re-entry Easy to communicate to

employees

Advantages: Equity

Between assignments

Between expatriates of the same nationality

Facilitate re-entry Easy to communicate to

employees

Disadvantages: Can result in great

disparities Between expatriates

of different nationalities

Between expatriates and local nationals

Can be complex to administer

May entail difficulty to attract human capital

Disadvantages: Can result in great

disparities Between expatriates

of different nationalities

Between expatriates and local nationals

Can be complex to administer

May entail difficulty to attract human capital

Table7-5


International Costs of Living

Multinationals using the Balance Sheet Approach must constantly update compensation packages with new data on living costs, which is an on-going administrative requirement.

Must also be able to respond to unexpected events, such as the currency and stock market crash, which suddenly unfolded in a number of Asian countries in late 1997.

The level of local knowledge requires specialist advice.

Multinationals using the Balance Sheet Approach must constantly update compensation packages with new data on living costs, which is an on-going administrative requirement.

Must also be able to respond to unexpected events, such as the currency and stock market crash, which suddenly unfolded in a number of Asian countries in late 1997.

The level of local knowledge requires specialist advice.

A 2003 survey of living costs ranked the 10 most expensive cities as: 1. Tokyo2. Moscow3. Osaka4. Hong Kong5. Beijing6. Geneva7. London8. Seoul9. Zurich10. New York

A 2003 survey of living costs ranked the 10 most expensive cities as: 1. Tokyo2. Moscow3. Osaka4. Hong Kong5. Beijing6. Geneva7. London8. Seoul9. Zurich10. New York


Cost of Living Worldwide Ranking 2007

1. Moscow

2. London

3. Seoul

4. Tokyo

5. Hong Kong

6. Copenhagen

7. Geneva

8. Osaka

9. Zurich

10. Oslo

1. Moscow

2. London

3. Seoul

4. Tokyo

5. Hong Kong

6. Copenhagen

7. Geneva

8. Osaka

9. Zurich

10. Oslo

11. Milan

12. St Petersburg

13. Paris

14. Singapore

15. New York City

16. Dublin

17. Tel Aviv

18. Rome

19. Vienna

20. Beijing

11. Milan

12. St Petersburg

13. Paris

14. Singapore

15. New York City

16. Dublin

17. Tel Aviv

18. Rome

19. Vienna

20. Beijing


Taxation

This aspect of international compensation probably causes the most concern to HR practitioners and expatriates (both PCNs and TCNs), as taxation generally evokes emotional responses. No one enjoys paying taxes, and this issue can be very time consuming for both the firm and the expatriate.

An assignment abroad can mean that a U.S. expatriate is taxed both in the country of assignment and in the USA. This dual tax cost, combined with all of the other expatriate costs, makes some U.S. multinationals think twice about making use of expatriates.


Approaches to Handling International Taxation:

Tax Equalization Firms withhold an amount equal to the home-country

tax obligation of the PCN, and pay all taxes in the host country.

Tax Protection The 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 total taxes are less in the foreign country than in the home country.

Ad hoc and Laissez-faire approaches


Tax Equalization

By far the more common taxation policy used by multinationals. For a PCN, tax payments equal to the liability of a home-

country taxpayer with the same income and family status are imposed on the employee’s salary and bonus.

Any additional premiums or allowances are typically paid by the firm, tax-free to the employee.

As multinationals operate in more and more countries, they are subject to widely discrepant income tax rates.

Just focusing on income tax can be misleading, as the shares of both personal and corporate taxes are rising in the OECD countries.


Diversity in National Taxation

If we look at total tax revenues as a percentage of GDP, the “top five” highest taxation countries are: Sweden, Denmark, Finland, France and Belgium The United States is 25th with the other large advanced

economies towards the bottom of the list Japan, 26th; Britain, 16th; and Germany, 12th.

International accounting firms may provide advice and prepare host-country and home-country tax returns for their expatriates.

Increasingly, firms are also outsourcing the provisions of further aspects of the total expatriate compensation packages including a variety of destination services in lieu of providing payment in a package.


Country

ArgentinaAustraliaBelgiumBrazilCanadaChina (Hong Kong)ChinaFranceGermanyIndiaItalyJapanMalaysia

Maximum marginal rate (%)

35.0047.0050.0027.5029.0020.0045.0048.0942.0033.6643.0037.0028.00

Maximum marginal federal tax ratesTable7-6


Federal Marginal Tax Rate

Income Tax Rate Table for 2008:

Single Married - JointHead of

HouseholdMarried - Separate

10% 0 - 8,025 0 - 16,050 0 - 11,450 0 - 8,025

15% 8,025 - 32,550 16,050 - 65,100 11,450 - 43,650 8,025 - 32,550

25% 32,550 - 78,850 65,100 - 131,450 43,650- 112,650 32,550 - 65,725

28% 78,850 - 164,550 131,450 - 200,300 112,650 - 182,400 65,725 - 100,150

33% 164,550 - 357,700 200,300 - 357,700 182,400 - 357,700 100,150 - 178,850

35% 357,700 and Up 357,700 and Up 357,700 and Up 178,850 and Up


Some issues when considering benefits

40IHRM Chapter 7

1. Keep expatriates in home-country programs, particularly if the company does not receive a tax deductions for it?

2. Enroll expatriates in host-country benefit programs and/or making up coverage differences?

3. Does host-country legislation regarding termination affects benefit entitlement?

4. Do expatriates receive home-country or host-country social security benefits?

5. Should benefits be maintained on a home-country or host-country basis? Who is responsible for the cost? Should other benefits offset any shortfall in coverage? Should home-country benefit programs be exported to local nationals in foreign countries?


Table7-7

Social security contributions by employers and employees


Table7-8

Range of working times required to buy one Big Mac


Complexity, challenges and choices in global pay

Figure7-1


Approaches to International Compensation Multinationals need to consider the extent to which

specific practices can be modified in each country to provide the most tax-effective, appropriate rewards for PCNs, HCNs and TCNs within the framework of the overall compensation policy of the firm.

The difficulties in international compensation “are not compensation so much as benefits”: Pension plans are very difficult to compare or equalize

across nations, as cultural practices vary endlessly. Transportability of pension plans, medical coverage and

social security benefits are very difficult to normalize.


Rank CountryAverage Real Salary: Senior Managers (€)

Rank CountryAverage Real Salary: Senior Managers (€)

1 Turkey 79,021 15 Netherlands 58,915

2 India 77,665 16 Czech Rep. 57,416

3 Russia 77,355 17 Australia 55,505

4 Switzerland 76,913 18 Canada 54,032

5 Brazil 76,449 19 Italy 53,003

6 Poland 76,269 20 France 51,396

7 Spain 75,904 21 Belgium 51,196

8 Germany 75,701 22 Denmark 48,228

9 Japan 69,634 23 U.K. 46,809

10 Austria 66,243 24 Slovakia 45,389

11 Portugal 66,191 25 Norway 42,939

12 Ireland 62,608 26 China 42,288

13 USA 61,960 27 Hungary 41,406

14 Greece 60,785 28 Finland 41,018

Average - 59,651 29 Sweden 37,652

World Pay Report: Emerging Economies Come First in New International Pay Stakes, 2006


A Wider View on Business Costs

Relate costs of doing business in different economies to statistic measures of: Wages of employees, more than expatriates Costs for expatriate staff Air travel and subsistence Corporation taxes Perceived corruption levels Office and industrial rents Road transport.

Generally the developed countries tend to rank as more expensive than developing countries because their wage costs are higher, but nothing is absolute.


Chapter Summary

In this chapter, we have examined the complexities arising when firms move from compensation at the domestic level to compensation in an international context.

It is evident from our review that compensation policy becomes a much less precise process than is the case in the domestic HR context.

To demonstrate this complexity, we have:


Chapter Summary (cont.) Detailed the key components of an international compensation

program. Outlined the two main approaches to international compensation

(the Going Rate and the Balance Sheet) and contrasted the advantages and disadvantages of each approach.

Outlined special problem areas such as taxation, obtaining valid international living costs data, and the problems of managing TCN compensation.

Presented a model of global pay that highlights the complexity and yet familiarity of pay practices in the global context.

The combination of pay decisions based on strategic global standardization and sensitivity to changing local and regional conditions that characterizes the state of international pay practices.


Implications for IHRM

Providing a strategic yet sensitive balance can only be achieved by creating and maintaining professional networks: comprised of home office and local affiliate HR practitioners, outsourcing selected activities through specialist consultants, and a close cooperation with local and regional governments and other key local institutions.

Providing a strategic yet sensitive balance can only be achieved by creating and maintaining professional networks: comprised of home office and local affiliate HR practitioners, outsourcing selected activities through specialist consultants, and a close cooperation with local and regional governments and other key local institutions.


Discussion Questions

1. What should be the main objectives for a multinational firm with regard to its compensation policies?

2. Describe the main differences in the Going Rate and Balance Sheet Approaches to international compensation.

3. What are the key differences in salary compensation for PCNs and TCNs? Do these differences matter?

4. What are the main points that MNEs must consider when deciding how to provide benefits?

5. Why is it important for MNEs to understand the compensation practices of other countries?

6. Explain how balancing the interests of global and local, occupational and functional perspectives might play out in a compensation decision scenario.

IBUS 618 Dr. Yang1 Chapter 7 International Compensation.

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Transcript of IBUS 618 Dr. Yang1 Chapter 7 International Compensation.