The Legal Environment and Pay System Governance

The legal framework exerts substantial influence on the design and administration of compensation systems. The key federal laws that govern compensation criteria and procedures are the Fair Labor Standards Act, the Equal Pay Act, and the Internal Revenue Code. In addition to these, each state has its own sets of regulations that complement federal law. Labor laws may also limit managerial discretion in setting pay levels.

The Fair Labor Standards Act

The Fair Labor Standards Act (FLSA) of 1938 is the compensation law that affects most pay structures in the United States. To comply with the FLSA, employers must keep accurate records of earnings and hours worked by all covered employees and must report this information to the Wage and Hour Division of the U.S. Department of Labor. Most businesses are covered by the FLSA, except those with only one employee or annual gross sales under $500,000.

The FLSA defines two categories of employees: exempt and nonexempt. Exempt employees are not covered by the provisions of the act; nonexempt employees are. Exempt categories include professional, administrative, executive, computer-related jobs, motor carriers, and outside sales jobs. The Department of Labor provides guidelines to determine whether a job is exempt or nonexempt. Although these regulations are subject to change, currently there are specific minimum weekly dollar figures below which a job may not be classified as exempt, namely $455/week for executive, administrative, professional, and computer positions. Managers are often tempted to classify as many jobs as possible as exempt to avoid some of the costs associated with nonexempt status, principally the minimum wage and overtime payments. However, there are heavy penalties for employers who unfairly classify nonexempt jobs as exempt.

This means that employers must be alert to new interpretations of the FLSA because they do occur from time to time. For instance, the deputy administrator of the FLSA recently announced that mortgage loan officers are no longer considered exempt under the FLSA and therefore are entitled to overtime pay. This announcement was a reversal from the department’s long-time policy on the status of mortgage loan officers and requires banks and other financial institutions to alter their pay practices accordingly to bring themselves into compliance.

Minimum Wages

The federal minimum wage set by the FLSA is currently $7.25 per hour, although in some states and cities it is considerably higher. For instance, in Connecticut and Illinois the minimum wage ($8.25 per hour) is almost 14 percent higher than the federal minimum wage, while in the state of Washington the minimum wage ($9.00 per hour) is 24 percent higher. Minimum wage legislation is controversial. Those in favor believe that it raises the standard of living for the poorest members of society. Those who oppose it argue that it results in higher levels of unemployment and poverty among low-skilled workers because it discourages firms from hiring and/or retaining workers. Opponents also claim that minimum wages encourage U.S. firms to open overseas plants in low-wage countries (such as Mexico and the Philippines), thereby creating more unemployment at home. This debate has not yet been resolved, probably because the minimum wage is set at a much lower level than most U.S. firms are willing to pay. However, the debate is being rekindled by a growing number of local governments passing “living wage” (wage needed to secure a decent standard of living) legislation that sets the minimum wage at a much higher level than the federal minimum of $7.25 per hour. For instance, the city of Santa Cruz, California, passed a requirement for public sector employers who contract or subcontract with the county to pay a “living wage” of $13.08 per hour, or $14.27 per hour if they do not provide benefits. At the time of this writing there is legislation pending in Congress to raise the minimum wage to $10.10 per hour minimum.

Overtime

The FLSA requires that nonexempt employees be paid one and a half times the standard wage for each hour they work over 40 hours a week. This provision was intended to stimulate hiring by making it more costly to expand production using existing employees. In fact, however, many firms would rather pay overtime than incur the costs associated with hiring additional employees (recruitment, training, benefits, and so on).

The U.S. Department of Labor requires that employers guarantee overtime for workers who earn up to $23,600 a year, up from the ceiling of $8,660 established in 1975. The change covers manual laborers, other blue-collar workers, and managers who earn $23,660 per year or less, whether they are paid a salary or an hourly wage. Employers can exempt white-collar workers from overtime pay who make more than $23,660 per year if they do some “professional, administrative, or executive” duties or are “team leaders,” whether or not they supervise workers.77

Overtime can make a big difference in an employee’s paycheck, and it can also derail an organization’s cost-cutting efforts. Consider, for instance, the following story. Like many other state employees in California, prison nurse Nellie Larot was hit with furloughs that cut her annual salary: It dropped $10,000, to $92,000. But she more than made up for it by working extra shifts, raking in $177,512 in overtime, according to state records. Her total $270,000 in earnings the same year eclipsed the $225,000 paid to Matthew Cate, then-head of the entire California state prison system. Ex-Governor Arnold Schwarzenegger’s decision to furlough workers three days a month was made to save money. Ironically, to make up for these lost hours and maintain minimum service levels, many employees who are filling the gap are taking home paychecks fattened by overtime—more than $1 billion in a single year.78

The Equal Pay Act

The Equal Pay Act (EPA) was passed in 1963 as an amendment to the FLSA. As we discussed in Chapter 3, i t requires that men and women be paid the same amount of money if they hold similar jobs that are “substantially equal” in terms of skill, effort, responsibility, and working conditions. The EPA includes four exceptions that allow employers to pay one sex more than the other: (1) more seniority; (2) better job performance; (3) greater quantity or quality of production; and (4) certain other factors, such as paying extra compensation to employees for working the night shift. If there is a discrepancy in the average pay of men and women holding similar jobs, managers should ensure that at least one of the four exceptions to the EPA applies to avoid legal costs and back pay to affected employees.

Comparable Worth

Equal pay should not be confused with comparable worth, a much more stringent form of legislation enacted in some countries and used in a few public jurisdictions in the United States. Comparable worth calls for comparable pay for jobs that require comparable skills, effort, and responsibility and have comparable working conditions, even if the job content is different. For instance, if a company using the point-factor job-evaluation system we described earlier finds that the administrative assistant position (held mostly by women) receives the same number of points as the shift supervisor position (held mostly by men), comparable worth legislation would require paying employees in these jobs equally, even though they might be exercising very different skills and responsibilities.

The considerable controversy surrounding comparable worth legislation centers mainly on how it should be implemented rather than on its main goal of pay equity between the sexes. Supporters of comparable worth legislation favor using job-evaluation tools to advance pay equity, pointing out that many private firms already use this method to set wages. Opponents argue that job evaluations are inherently arbitrary and that they do not take sufficient account of jobs’ market value. For example, comparable worth proponents have often said that markets treat nurses unfairly because society links the profession to women’s unpaid nurturing role in the family. Despite all the problems with implementation, comparable worth is already being used in many countries, including Britain, Canada, and Australia.79

Role of the Office of Federal Contract Compliance Programs (OFCCP)

The OFCCP may evaluate compensation in an effort to monitor compliance with EEO. This agency has extensive powers because it may revoke federal government contracts from employers—a costly loss in revenue for many firms.

During the past 40 years, OFCCP has focused most of its efforts on the implementation of affirmative action plans (see Chapter 3). Recently, however, that emphasis seems to have shifted to more focused investigations of discrimination claims, sometimes involving groups who are not considered protected classes (see Chapter 3). For instance, recently more than 530 African American and Caucasian workers who were turned down for jobs with Tyson Refrigerated Processed Meats, Inc. in Vernon, Texas, recovered $560,000 in back pay and interest under a conciliation agreement the company signed with the OFCCP. Fifty-nine of the workers will receive job offers as laborer positions become available at the bacon-processing plant. “The Labor Department is committed to leveling the playing field for all workers,” said OFCCP director Patricia A. Shiu. “A company that profits from taxpayer dollars must not discriminate, period!” The settlement, known as a conciliation agreement, resolves an investigation by OFCCP into the facility’s hiring practices, which showed that African American and Caucasian job applicants were much less likely to be hired than similarly situated Hispanics applicants. As a federal contractor, Tyson is prohibited from discriminating against workers on the basis of gender, race, sex, religion, nationality, disability, or status as a protected veteran.80 Other recent cases where the OFCCP negotiated major settlements for past wage discrimination include Goodwill Industries, Bertucci Contracting Co. LLC, and shipping giant Federal Express.81

The Internal Revenue Code

The Internal Revenue Code (IRC) affects how much of their earnings employees can keep. It also affects how benefits are treated for tax purposes, as we discuss in Chapter 12 . The IRC requires the company to withhold a portion of each employee’s income to meet federal tax obligations (and, indirectly, state tax obligations, which in most states are set as a percentage of the federal tax withholding).

Tax laws change from time to time, and these changes affect an employee’s take-home pay as well as what forms of compensation can be sheltered from taxes. An employer’s failure to take advantage of IRC legislation may result in wasted payroll dollars. For instance, the tax laws currently treat short-term capital gains (profits) on the sale of stock as ordinary income. This reduces the motivational value of stock as a long-term pay incentive because employees bear more risk with stock than with a cash-based form of pay. However, setting the capital gains tax below the tax on ordinary income could make stock more attractive to employees as a pay incentive.

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