Chapter 18 Outline

Compensation

Two issues are raised in every discussion of compensation practices in an international business. One is how compensation should be adjusted to reflect national differences in economic circumstances and compensation practices. The other issue is how expatriate managers should be paid.

National Differences in Compensation

Substantial differences exist in the compensation of executives at the same level in various countries. For example, the average CEO of a large public company in the United States made $2.3 million in salary and bonuses in 1996, and this went up to $5.8 million when stock options were included. In 1997, the figure soared to $7.8 million. In comparison, the average pay of foreign executives is much lower. The CEO of a large public Japanese firm, such as Sony or Matsushita, makes $1.2 million to $1.5 million per year. In Europe, when it was announced that Pierre Suard, then the CEO of French-based telecommunications equipment supplier Alcatel Alsthom, made $2.5 million, it sparked a scandal and much hand-wringing about the excesses of executive pay. According to Towers Perrin, an international human relations consulting firm, the average CEO of a firm in the United States, big or small, public or private, made $927,896 in salary and bonuses (excluding stock options) in 1996. By contrast, the average total pay was $600,052 for a French CEO, $558,457 for a Japanese, $512,651 for a German, and $483,815 for a British. These figures underestimate the true differential because many US executives earn considerable sums of money from stock options and grants, while the practice of granting options is still rare in other nations.⁴³

These differences in compensation raise a perplexing question for an international business: Should the firm pay executives in different countries according to the prevailing standards in each country, or should it equalize pay on a global basis? The problem does not arise in firms pursuing ethnocentric or polycentric staffing policies. In ethnocentric firms, the issue can be reduced to that of how much home-country expatriates should be paid (which we will consider later). As for polycentric firms, the lack of managers' mobility among national operations implies that pay can and should be kept country-specific. There would seem to be no point in paying executives in Great Britain the same as US executives if they never work side by side.

However, this problem is very real in firms with geocentric staffing policies. A geocentric staffing policy is consistent with a transnational strategy. One aspect of this policy is the need for a cadre of international managers that may include many different nationalities. Should all members of such a cadre be paid the same salary and the same incentive pay? For a US-based firm, this would mean raising the compensation of foreign nationals to US levels, which could be very expensive. If the firm does not equalize pay, it could cause considerable resentment among foreign nationals who are members of the international cadre and work with US nationals. If a firm is serious about building an international cadre, it may have to pay its international executives the same basic salary irrespective of their country of origin or assignment. The accompanying Management Focus contains several examples of how some international businesses have tried to deal with this problem.

Expatriate Pay

The most common approach to expatriate pay is the balance sheet approach. This approach equalizes purchasing power across countries so employees can enjoy the same living standard in their foreign posting that they enjoyed at home. In addition, the approach provides financial incentives to offset qualitative differences between assignment locations.⁴⁴ Figure 18.1 shows a typical balance sheet. Note that home-country outlays for the employee are designated as income taxes, housing expenses,

Figure 18.1

A Typical Balance Sheet

Source: C. Reynolds, "Compensation of Overseas Personnel," in Handbook of Human Resource Administration, 2nd ed., ed. J. J. Famularo (New York: McGraw-Hill, 1986), p. 51.

expenditures for goods and services (food, clothing, entertainment, etc.), and reserves (savings, pension contributions, etc.). The balance sheet approach attempts to provide expatriates with the same standard of living in their host countries as they enjoy at home plus a financial inducement (i.e., premium, incentive) for accepting an overseas assignment.

The components of the typical expatriate compensation package are a base salary, a foreign service premium, allowances of various types, tax differentials, and benefits. We shall briefly review each of these components.⁴⁵ An expatriate's total compensation package may amount to three times what he or she would cost the firm in a home-country posting. Because of the high cost of expatriates, many firms have reduced their use of them in recent years. However, a firm's ability to reduce its use of expatriates may be limited, particularly if it is pursuing an ethnocentric or geocentric staffing policy.

Base Salary

An expatriate's base salary is normally in the same range as the base salary for a similar position in the home country. The base salary is normally paid in either the home-country currency or in the local currency.

Foreign Service Premium

A foreign service premium is extra pay the expatriate receives for working outside his or her country of origin. It is offered as an inducement to accept foreign postings. It compensates the expatriate for having to live in an unfamiliar country isolated from family and friends, having to deal with a new culture and language, and having to adapt new work habits and practices. Many firms pay foreign service premiums as a percentage of base salary ranging from 10 to 30 percent after tax with 16 percent being the average premium.⁴⁶

Allowances

Four types of allowances are often included in an expatriate's compensation package: hardship allowances, housing allowances, cost-of-living allowances, and education allowances. A hardship allowance is paid when the expatriate is being sent to a difficult location, usually defined as one where such basic amenities as health care, schools, and retail stores are grossly deficient by the standards of the expatriate's home country. A housing allowance is normally given to ensure that the expatriate can afford the same quality of housing in the foreign country as at home. In locations where housing is very expensive (e.g., London, Tokyo), this allowance can be substantial--as much as 10 to 30 percent of the expatriate's total compensation package. A cost-of-living allowance ensures that the expatriate will enjoy the same standard of living in the foreign posting as at home. An education allowance ensures that an expatriate's children receive adequate schooling (by home-country standards). Host-country public schools are sometimes not suitable for an expatriate's children, in which case they must attend a private school.

Taxation

Unless a host country has a reciprocal tax treaty with the expatriate's home country, the expatriate may have to pay income tax to both the home- and host-country governments. When a reciprocal tax treaty is not in force, the firm typically pays the expatriate's income tax in the host country. In addition, firms normally make up the difference when a higher income tax rate in a host country reduces an expatriate's take-home pay.

Benefits

Many firms also ensure that their expatriates receive the same level of medical and pension benefits abroad that they received at home. This can be very costly for the firm, since many benefits that are tax deductible for the firm in the home country (e.g., medical and pension benefits) may not be deductible out of the country.