Compensation System For Multinational Corporations Economics Essay

Global compensation managers that is, everyone involved at any level in pay-related decisions 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. For multinationals successfully to manage compensation and benefits requires 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 an 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.

DIFFERENCE BETWEEN MULTI NATIONAL CORPORATION (MNC)

AND TRANS NATIONAL CORPORATION (TNC)

The both multinationals corporations and transnational corporations operate internationally and their compensation or reward system is also similar, but some differences exist between two, which are:

MNCs operate in several different countries while transnational implies “just across the border” as in the US and Canada. Obviously, both operate internationally

A MNC has a centralized headquarters & is a corporation with extensive ties international operations in more than one foreign country. Examples are Coke, Pepsi, General Electric, Exxon, Wal-Mart, and Mitsubishi.

A transnational company has no “head office” and moves whatever base of operations it has fluidly between its national offices. It is a MNC that operates worldwide without being identified with a national home base i.e. it is said to operate on a borderless basis. Examples are Daewoo, Saint Gobain, Sony, Samsung Group, Shell Oil etc.

OBJECTIVES OF INTERNATIONAL COMPENSATION

When developing international compensation policies, a firm seeks to satisfy several objectives.

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

The policy must work to attract and retain staff in the areas where the multinational has the greatest needs and opportunities. Hence the policy must be competitive and recognize factors such as incentive for Foreign Service, tax equalization and reimbursement for reasonable costs.

The policy should facilitate the transfer of international employees in the most cost-effective manner for the firm.

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 the policy to offer financial protection in terms of benefits, social security and living costs in the foreign location. Second, the employee will expect a foreign assignment to offer opportunities for financial advancement through income and/or savings. Third, the employee will expect issues such as housing, education of children and recreation to be addressed in the policy.

If we contrast the objectives of the multinational and the employee, we see, of course, the potential for many complexities and possible problems, as some of these objectives cannot be maximized on both sides. Firms must rethink the traditional view that local conditions dominate international compensation strategy.

COMPENSATION MANAGEMENT OR SYSTEM

The type and amount of compensation necessary to attract technically and culturally qualified international managers and technical professionals to the three nationals or country categories involved international human resource management activities from which employees are selected whether the people are:

PCNs (parent country nationals)

TCNs (third country nationals)

HCNs (host country nationals)

An expatriate is an employee working in a country other than their country of origin.

PCNs (Parent Country Nationals)

Those personnel who are of the same nationality as the contracting government or personnel from headquarters

They come from the home country of the operation.

The policy of using PCNs is usually employed when one or more of the following situations exist: (1) the host country cannot readily supply desired managerial personnel, (2) efficient communication with headquarters is required, and (3) the company adopts a centralized approach to globalization.

TCNs (Third Country Nationals)

Those personnel of a separate nationality to both the contracting government and the area of operations i.e. whose nation of residence is neither the host country nor the home country.

Such an employee normally is recruited from outside the host country and relocated from the point of recruitment to the host country.

HCNs (Host Country Nationals)

These are Indigs (Indigenous Personnel) / Nationals / Locals – those personnel who are indigenous to the area of operations

Whose basic residence or home is the host nation.

Local colleagues of the expatriate, they are valuable socializing agents, sources of social support, assistance, and friendship to expatriates. Expatriates are more likely to adjust when HCNs engage in this behavior.

HR managers focus on their strategic objectives to develop a comprehensive compensation plan, in terms of considering base pay, short and long-term incentives, benefits and growth opportunities. The objective of this kind of strategy is to ensure that both TNC/MNCs’ long and short-term objectives coexist in the compensation system without overlap, which would duplicate a single pay plan for the same objectives. The purpose of the planning is also designed to ensure that the compensation system attracts and retains the desired employees and that it motivates them to do those things that support the business plan.

KEY COMPONENTS OF AN INTERNATIONAL COMPENSATION

PROGRAM

The area of international compensation is complex primarily because multinationals must cater to three categories of employees: PCNs, TCNs and HCNs.

Key components of international compensation are as follows:

COMPONENTS OF MNC’S COMPENSATION

BASIC SALARY

ALLOWANCES

OTHER BENEFITS

1. 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, 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) and also 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.

The definition of hardship, eligibility for the premium and amount and timing of payment must be addressed. In cases in which hardship is determined, US firms often refer to the US Department of State’s Hardship Post Differentials Guidelines to determine an appropriate level of payment.

Making international comparisons of the cost of living is problematic. 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 5-40 per cent of base pay. Such payments vary, depending upon the assignment, actual hardship, tax consequences and length of assignment.

2. Allowances

Issues concerning allowances can be very challenging to a firm establishing an overall compensation policy, partly because of the various forms of allowances that exist.

(a)The cost-of-living allowance (COLA), which typically receives the most attention, involves a payment to compensate for differences in expenditures between the home country and the foreign country (to account for inflation differentials, for example). The COLA may also include payments for housing and utilities, personal income tax or discretionary items.

(b)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).

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

(c)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. 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.

(d)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 board and uniforms. PCNs and TCNs usually receive the same treatment concerning educational expenses.

(e)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, servants10 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.

(f)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 a spouse’s lost income, US 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).

(g)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 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.

3. 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, as national practices vary considerably.

Transportability of pension plans, medical coverage and social security benefits are very difficult to normalize.

Firms need to address many issues when considering benefits, including:

Whether or not 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.

In some countries, expatriates cannot opt out of local social security programs. In such circumstances, the firm normally pays for these additional costs.

Laws governing private benefit practices differ from country to country, and firm practices also vary. Multinationals have generally done a good job of planning for the retirement needs of their PCN employees, but this is generally less the case for TCNs.

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.

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. 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.

ADDITIONAL PAYMENTS AND SERVICES

Lifestyle enhancement services

• Provision for employee & family to learn the local language

• Education & training of employee & family on local culture, customs and social expectations

• Counseling services for employee & family

• Assistance in finding a home at the foreign work site / school & suitable education programmes for children & dependents

• Company car, driver, domestic staff, and child care

• Use of Fitness facilities / subsidized health care services

• Assistance in joining local civic, social, professional organizations

Allowances & Premiums

• Foreign Service premium & tax equalization allowance

• Temporary living allowance

• Currency protection

• Mobility premium

• Stopover allowance

• Completion of assignment bonus

• Assignment extension bonus

• Emergency loan

• Extended work-week payment

APPROACHES TO INTERNATIONAL COMPENSATION

There are two main approaches in the area of international compensation –

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

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

(a)The Going Rate Approach

With this approach, the base salary for international transfer is linked to the salary structure in the host country. The multinational usually obtains information from local compensation surveys and must decide whether local nationals (HCNs), expatriates of the same nationality or expatriates of all nationalities will be the reference point in terms of benchmarking. For example, a Japanese bank operating in New York would need to decide whether its reference point would be local US salaries, other Japanese competitors in New York or all foreign banks operating in New York.

With the Going Rate Approach, if the location is in a low-pay county, the multinational usually supplements base pay with additional benefits and payments.

The Balance Sheet Approach

The basic objective is to ‘keep the expatriate whole’ (that is, maintaining relativity to PCN colleagues and compensating for the costs of an international assignment) through maintenance of home-country living standard plus a financial inducement to make the package attractive. The approach links the base salary for PCNs and TCNs to the salary structure of the relevant home country. For example, a US executive taking up an international position would have his or her compensation package built upon the US base-salary level rather than that applicable to the host country.

The key assumption of this approach is that foreign assignees should not suffer a material loss due to their transfer, and this is accomplished through the utilization of what is generally referred to as the Balance-sheet Approach.

COMPENSATION ISSUES IN INTERNATIONAL SCENARIO

Incentives provided to stimulate movement or expatriation to a foreign location/ host country

Allowances for repatriation to home country

Additional tax burdens placed on employees working in a foreign location

Labour regulations in home and host country

Cost-of-living allowances in the host country

Home country and host country currency fluctuation

Formal and informal compensation practices unique to the host country

Determining home country for setting base pay of TCNs

MANAGEMENT CHALLENGES CONCERNING INTERNATIONAL

BENEFITS & COMPENSATION

Compensation is one of the most complex areas of international human resource

management

Pay systems must conform to local laws and customs for employee compensation while also fitting into global MNC policies

Managers face diverse political systems, laws & regulations; confront different economic climates, economic development, tax policies, diverse culture, customs, the role of labor unions, standard of living

It is also important for MNCs to consider carefully the motivational use of incentives and rewards among the employees drawn from three national or country categories

The traditional function of pay to attract, retain and motivate employees has not changed – The emphasis has shifted from the attraction and retention functions to the motivation function.

TNC/MNCs must ensure that those skilled employees are compensated for achieving goals that make the international business operations succeed

HR managers focus on their strategic objectives to develop a comprehensive compensation plan, in terms of considering base pay, short and long-term incentives, benefits and growth opportunities

The objective of this kind of strategy is to ensure that both TNC/MNCs’ long and short-term objectives coexist in the compensation system without overlap, which would duplicate a single pay plan for the same objectives.

The purpose of the planning is also designed to ensure that the compensation system attracts and retains the desired employees and that it motivates them to do those things that support the business plan

The compensation costs of a family with children are shifted to hardship allowance for schooling, childcare, increased residence cost and all fringe benefits associated with supporting a family life cycle

It may be that international compensation administration is more complex than its domestic counterpart, but not radically different in pattern or form.

QUESTIONS:-

Q1. What is international compensation system? Explain its objectives.

Q2. Explain the parties involved in international compensation system?

Q3. List the components of an international compensation program.

Q4. Explain the approaches to international compensation system.

Q5. What are different challenges faced by the management concerned to various benefits in international compensation program.