INTERNATIONAL HUMAN RESOURCE MANAGEMENT

LESSON 20: ELEMENTS OF INTERNATIONAL COMPENSATION Learning Objectives 1. The objectives that can be pursued through compensation system. 2. Key components of international compensation program 4. Foreign service inducement/ Hardship premium

First, the policy should be consistent with the overall strategy, structure, and business needs of the multinational.

5. Allowances 6. Benefits.

Introduction For multinational firms, successful management of compensation and benefits requires knowledge of the employment and taxation laws, customs, environment, and employment practices of many foreign countries. Also needed are familiarity with currency fluctuations and the effect of inflation on compensation, and an understanding of why and when special allowances must be supplied and which allowances are necessary in what countries. All of these needs must be fulfilled within the context of shifting political, economic, and social conditions. The level of local knowledge required in many of these areas requires specialized advice; many multinationals retain the services of consulting firms which may offer a broad range of services or provide highly specialized services relevant to HRM in multinational context. Because of their 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 fund that 29 percent of firms reported an expatriate cost of 2 to 2,9 times salary, 50 percent reported 3 to 3.9 times salary, and 18 percent reported 4 to 4,9 times salary. A recent report in Fortune on doing business in China reported that hiring a local Chinese manager with 15 years of experience would cost less than U.S.$70,000; a U.S. expatriate chief financial officer would cost U.S.$300,000 with the following compensation package (all figures in U.S.$: Salary $130,000 Car and driver 12,000 Benefits: Medical

3,000

Pension

13,000

Housing

97,000

Flights home

10,000

R and R

10,000

Private School for children

25,000 _______ 300,000

Because of the complexity and expense involved, much of the discussion in this lesson addresses PCN compensation. However, issues relevant to TCNs and HCNs are also described

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Objectives of International Compensation When developing international compensation policies, a firm seeks to satisfy several objectives.

3. Base salary

Total $

because they are becoming more important to the success of many multinationals.

Second, the policy must work to attract and retain staff in the areas where the multinational has the greatest needs and opportunities. Thus, the policy must be competitive and recognize factors such as incentive for Foreign Service, tax equalization, and reimbursement for reasonable costs. Third, the policy should facilitate the transfer of international employees in the most cost-effective manner for the firm. Fourth, the Policy must give due consideration to equity and ease of administration. The international employee will also have a number of objectives that need to be achieved from the firm’s compensation policy. First, the employee will expect that the policy offers financial protection in terms of benefits, social security, and living costs in the foreign location. Second, the employee will expect that a foreign assignment will offer opportunities for financial advancement through income and/or savings. Third, the employee will expect that issues such as housing, education of children, and recreation will be addressed in the policy. (The employee will also have expectations in terms of career advancement and repatriation, as discussed in previous lessons). If we contrast the objectives of the multinational and the employee, we see the potential for many complexities and possible problems since some of these objectives cannot be maximized on both sides. The “war stories” about problems in international compensation that we read in HR practitioner magazines is testimony to these complexities and problems. If we take away the specialist jargon and allow for the international context, are the competing objectives of the firm and the employee fundamentally different from that which exists in a domestic environment? We think not, and agree with the broad thrust of a challenging article by Milkovich and Bloom, which argues that firms must rethink the traditional view in international compensation, that local conditions dominate compensation strategy. We will cover some of the technical aspects and complexities of compensation in an international context.

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Key Components of an International Compensation Program The area of international compensation is complex primarily because multinationals must cater for three categories of employees; PCNs, TCNs, and HCNs. In this lesson, we discuss key components of international compensation, which include base salary, foreign service inducement/hardship program, allowance, and benefits. Base Salary The term base salary acquires a somewhat different meaning when employees go abroad. In a domestic context, base salary denotes the amount of cash compensation that serves as a benchmark for other compensation elements (e.g., bonus and benefits). For expatriates, it is the primary component of a package of allowances, many of which are directly related to base salary (e.g. Foreign Service premium, cost-of-living allowance, housing allowance) as well as the basis for in-service benefits and pension contributions. It 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 / 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. Under such circumstances, the definition of hardship, eligibility for the premium, and amount and timing of payment must be addressed.In cases in which hardship id determined, U.S. firms often refer to the U.S. Department of State’s Hardship’s Post Differentials Guidelines to determine an appropriate level of payment. As Ruff and Jackson have noticed, however, making international comparisons of the cost of living is problematic. It is important to note that these payments are more commonly paid to PCNs than TCNs. Foreign service inducements, if used, are usually made in the form of a percentage of salary, usually 5 to 40 percent of base pay. Such payments vary, depending upon the assignment, actual hardship, tax consequences, and length of assignment. In addition, differentials may be considered; for example, hostcountry’s work week may be longer than that of the home country, and differential payment may be made in lieu of overtime, which is not normally paid to PCNs or TCNs. Allowances Issues concerning allowances can be very challenging to a firm establishing an overall compensation policy, partly because of the various firms of allowances that exist. The cost-of-living allowance (COLA), which typically receives the attention, involves a payment to compensate for differences in expenditures between the home country and the foreign country (e.g., to account for inflation differentials). Often this 72

allowance is difficult to determine, so companies may use the services of organizations such as Organization Resource Counsellors, Inc., (a U.S. based firm) or Employment Conditions Abroad (based in Britain) who specialize in providing regular up-to-date COLA information on a global basis to their clients; the 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 a accommodations that are equivalent to that provided for similar foreign employees and peers). Such allowances are often paid on either an assessed or an 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. Housing issues are often addressed on a case-by-case basis, but as firm internationalises, formal policies become more necessary and efficient. Financial assistance and/or protection in connection with the sale or leasing of an expatriate’s former residence are offered by many multinationals. Those in the banking and finance industry tend to be the most generous, offering assistance in sale or leasing, payment of closing costs, payment of leasing management fees, rent protection, and equity protection. Again, TCNs receive these benefits less frequently than PCNs. There is also a provision for home leave allowances. Many employers cover the expense of one or more trips back to the home country each year. The purpose of paying for such trips is to give expatriates the opportunity to renew family and business ties, thereby helping them to avoid adjustment problems when they are repatriated. Although firms traditionally have restricted the use of leave allowances to travel home, some firms give expatriates the option of applying the allowances to foreign travel rather than returning home. Firms allowing use of home leave allowances for foreign travel need to be aware that expatriate employees with limited international experience who opt for foreign travel rather than returning home may become more homesick than other expatriates who return home for a “reality check” with fellow employees and friends. Education allowances for expatriates’ children are also 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 hoard, and uniforms (outside of the United States, it is quite common for high school students to wear uniforms). 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 multinationals. PCNs and TCNs usually receive the same treatment concerning educational expenses. The employer typically covers the cost of local or boarding schools for dependent children, although there may be restrictions, depending on the availability of good local schools and on their fees.

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needs of their PCN employees, but this is generally less the case for TCNs.

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.

There are many reasons for this; TCNs may have little or no home-country social security coverage, they may have spent many years in countries that do not permit currency transfers of accrued benefit payments, or they may spend their final year or two of employment in a country where final average salary is in a currency that relates unfavourably to their home-country currency.

Allowances regarding perquisites (cars, club memberships, servants, etc.) 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. Increasingly, as indicated earlier, many multinational firms are also offering spouse assistance to help guard against or offset income lost by an expatriate’s spouse as a result of relocating abroad. Although some firms may pay an allowance to make up for 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 unit (subject to a work visa being available). Multinationals generally pay allowances in order to encourage employees to take international assignments and to keep employees “whole” relative to home standards. In terms of housing companies usually 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. Benefits The complexity inherent in international benefits often brings more difficulties than when dealing with compensation. Pension plans are very 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. Therefore, firms need to address many issues when considering benefits, including: • Whether to maintain expatriates in home-country 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. Most U.S. PCNs typically remain under their home country benefit plan. In some countries, expatriates cannot opt out of local social security programs; in such circumstances, the firm normally pays for these additional costs.

How their benefits are calculated and what type of retirement plan applies to them may make the difference between a comfortable retirement in a country of their choice and a forced penurious retirement elsewhere. In addition to the already discussed benefits, multinationals also provide vacations and special leave. Included as part of the employee’s regular vacation, 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, also provides the employee’s family with free airfares to a more comfortable location near the host country. In addition to rest and rehabilitation leave, emergency provisions are available in case of a death or illness in the family. Employees in hardship locations often receive additional leave expense payments and rest and rehabilitation periods.

Summary We have examined the complexities which arise when firms move from compensation at the domestic level to compensation in an international context. Compensation policy becomes a much less precise process than is the case in the domestic HR context. We have detailed the key components of an international compensation program

The Questions that must Prick Your Mind 1. What are the objectives of international compensation? 2. What are the key components of international compensation package? 3. What are the different allowances that are a part of international compensation package? 4. What is hardship premium?

References 1. Peter J. Dowling, Denice E.Welch, Randal S. Schuller, 2002, International Human Resource Management: Managing people in a multinational context, Banglore, Thompson South Western. 2. Ian Beardwell, Len Holden,1995,Human Resource Management: A contemporary Perspective, New Delhi, Macmillan.

Notes

European PCNs and TCNs enjoy portable social security benefits within the European Union. Laws governing private benefit practices differ from country to country; firm practices also vary. Not surprisingly, multinationals have generally done a good job of planning for the retirement

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