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COLLEGE INSTRUCTORS

Chapter 22: International Remuneration

CHAPTER 22: INTERNATIONAL REMUNERATION

Overview: This textbook chapter examines how to set pay and benefits for expatriates and employees in multiple countries.

Corresponding courses:

91 Multiple Country Compensation Programs

92 Determining an Expatriate's Compensation

INTRODUCTION

A young Compensation Manager was walking around an automobile agency as her car was being serviced. She was looking at the stickers on the new cars. One of the pieces of information struck her forcefully. It told what percentage of the parts that went into the car came from what countries. Around six countries were listed, and the country the car was assembled in constituted around 40% of the parts. Later, while sorting through her clothes, she started noting where they were manufactured. The list included many countries in different parts of the world, but almost none were made in the U.S. What these two observations illustrate is a change in the world economy, called globalization. Products are being produced and sold in worldwide markets, not national markets.

This globalization has come about from two trends. The first is the internationalization of marketing. The revolution in communications has made the demand for goods and services worldwide. This potential worldwide market has been made practical by the increasing standards of living throughout the world. An increasing number of companies now see their marketplace as the world or at least a continent, rather than a country. The second trend has been the drive to reduce the costs of production. Placing production facilities in other countries takes advantage of lower costs, usually lower labor costs. In addition, being closer to the market also provides flexibility to adapt to local needs.1

The result of both of these trends is that companies now have offices and/or plants all over the world. These facilities need to be staffed and the question becomes, "by whom?" The choice is either to relocate current employees from another location, involving international transfers, or to hire local people. Staffing an overseas facility can be done using three different groups of people. The first and most obvious are natives of the host country, termed for this purpose, local country nationals (LCN), that is, hiring local Spaniards for an office in Madrid, Spain. A second group would be present employees or new hires from the home country of the company. These people are called expatriates. An accountant working for an American company transferred from St. Louis to Madrid is an expatriate. Lastly, the company could also transfer an accountant from its office in Hong Kong to the new office in Madrid. This person would be called a third country national (TCN). Each of these types of employees requires a compensation program that is different from the home country program, and to a degree, different from each other.2 This chapter looks at these special compensation programs.

EXPATRIATE COMPENSATION

Companies choose to send current employees to an assignment in another country for a number of reasons. A major reason is that the knowledge and skills needed in the job in the host country are not present in the natives of that country or are in short supply. Another related reason is that the current employee has knowledge of the company that is necessary for coordinating activities in the foreign branch with the home company. A third reason is to provide managers and executives with the kind of development and perspective needed to be an executive in this new global economy. Employees chosen for this reason may be at an early stage of their career or at a later stage when they are being groomed for a high level position.3

Expatriate assignments may be of a short (less than a year) or longer period of time. Most expatriate assignments from the U.S. are for two to three years. In Japan they are longer, usually five years. Short-term assignments are ordinarily handled as temporary assignments that don't require a change in pay or benefits. The assignee is given regular pay plus a per diem for living expenses. These per diems can be viewed by going to the ERI's Relocation Assessor® software and clicking on the third tab, "Estimated Per Diems." For reasons to be discussed later, short-term assignments are becoming more popular.

Long-term assignments are a different situation. These may represent the most complex compensation programs. Expatriate compensation starts from a presumption that in order to maintain equity and be able to attract employees to take these assignments, you must "keep the employee whole."4 The basic parts of expatriate compensation are like most compensation: base pay, variable pay, and benefits. However, added to this is a series of allowances and tax considerations.

Base Pay

Base pay for the expatriate should start with what the person would be paid for doing the job in the home country. This figure can be arrived at by using one of two methods. The first is to evaluate the job using the company's job evaluation plan. This may need to be adapted to recognize that the employee will be operating in a foreign environment in which home country supervision is impossible.

The second method is to determine the market worth of the job. This can be done using the ERI Salary Assessor® software. The first step is to determine the appropriate job title. This can be done by clicking on the job title in the center of the screen. A screen appears that allows you to type in a proposed title, or you can go to the filter option and type in the probable title to obtain all the possible titles in that area. Once the appropriate job title is determined, click on the "Data that Affects Salaries" banner. The first of these is location. A decision needs to be made here. The company may choose to "send" the expatriate from his/her current location or from company headquarters. The former, called home-country based method, relates pay to the expatriate’s home whereas the latter, called headquarters based method, provides a consistency among all expatriates. The other two decisions, company industry and size, can then be recorded. The main screen now has salary figures that can be used to determine the appropriate base salary when the person's experience and performance level is taken into account. Salary Assessor data is also available for Canada, the U.K. and the E.U.

With the home country based method, base pay can be set if the headquarters based method is used. The second situation, in which the Salary Assessor can be used only if the host country is Canada, the U.K. or E.U., is called the host country based method. This method calls for setting base pay in relation to how the job is paid in the host country. This provides consistency among the workforce in the country but can create major problems in convincing home country employees to accept expatriate assignments to countries that have low wage rates. It also creates problems of repatriation if the host country has high wages. As we shall discuss later, obtaining wage data for countries other than the U.S. is difficult but getting easier as globalization increases. For instance, ERI'S SalariesReview.com's online "International Remuneration" survey provides wage data for various job titles in 210 countries.

Variable Pay

Variable pay plans for expatriates can be structured similar to domestic programs. A major concern, however, is that the supervisor is far away and may not be fully apprised of the performance of the expatriate. Added to this problem is the fact that goals and performance standards for expatriate assignments are often not carefully spelled out.

Variable pay can be in the form of short-term bonuses or long-term incentives, such as stock options or other devices discussed in chapter 18 on Executive pay. The incidence of variable pay has been rising dramatically in recent years. While expatriates do like variable pay, they tend not to want it to be too much of their total compensation.5

Bonuses

Besides the performance bonuses of variable pay, it may be necessary to offer a bonus to entice an employee to undertake a foreign assignment. This bonus can take a number of forms. One form is a percentage added to base pay, ranging from 10% to 30% of base pay.6 The problem with this approach is the expatriates come to see this as a part of base pay; when they are repatriated, this bonus disappears and is seen as a pay cut. A second approach is a lump sum payment at the beginning of the assignment. The advantage of this is that it provides cash to expatriates at a time when their expenses are high. The disadvantage to this approach is that it increases the employee's income in one year and may raise his or her tax rate. A third approach that tries to work between the first two is to have a schedule of bonus payments, clearly separated from base pay. These payments are weighted to the beginning of the assignment and then distributed before the expatriate is brought back home.

Allowances

The major difference between domestic pay practices and expatriate pay programs is the addition of allowances. Transferring an employee overseas is expensive. It involves the movement of a whole household of goods, the employee and family. The employee and family then arrive in a country where they are unfamiliar with the culture and customs. They must establish all the connections that a family needs in these unfamiliar surroundings.

Company assistance programs may include language training and a course in the local culture and customs. After arrival, employees also need help in finding adequate housing, schools, shopping areas, medical facilities, and a host of other things that a move to a new area entails.

Cost-of-living allowance. In order to "keep the employee whole," the living standard of the expatriate needs to be retained. Bringing a standard of living up to American norms in a foreign country is usually very expensive. Figure 22-1 illustrates some of these differences. In order to retain their standard of living , the expatriate is given an allowance so that the family may live as closely as possible to how they would live in the U.S. This allowance is a percentage of base pay. It is calculated based upon the difference in the cost of living between the host country and the expatriate’s hometown or headquarters.

This cost of living differential can be obtained from a number of sources. ERI's Relocation Assessor database is one such source. The main screen allows one to compare living costs between over 8,000 cities worldwide. The percentage difference can then be applied to the base pay in order to determine the appropriate allowance. Cost-of-living information may also be obtained at SalariesReview.com. Finally, a useful government site that provides information on overseas costs is : www.state.gov/www/perdiems/quarterly_reports/index.html.

Cost-of-Living Differentials Between Chicago and International Cities
Brussels, Belgium +12.7%
Buenos Aires, Argentina +3.1%
Johannesburg, South Africa +4.4%
Paris, France +75.8%
Madrid, Spain +8.0%
Nairobi, Kenya -28.3%
Rio De Janeiro, Brazil +5.9%
Riyadh, Saudi Arabia +14.1%
Singapore, Singapore +28.3%
Tel Aviv, Israel -3.2%
Tokyo, Japan +91.3%
Victoria, Hong Kong +62.7%
Data as of 1/1/2010

Figure 22-1. Cost-of-Living Differentials Between Chicago and Select International Cities.

What if the cost of living in the host country is lower than in the home country? It would seem logical to apply a negative allowance to the expatriate's base pay. This obviously is not a popular idea, but with proper communication and explanation may be possible. In terms of equity with local employees or TCNs, it may be a necessary practice.

Education allowances. Children of expatriates usually attend private schools in the host country. This is partly because of the variable nature of public education in other countries and partly because the children of expatriates are not always fluent in the language of the host country. Typically, companies pay for this added expense, as this can be a costly proposition for the expatriate to bear. For information about schools, see International School Services www.iss.edu, the U.S. Department of State www.state.gov/m/a/os/, and the European council of International Schools www.ecis.org.

Hardship and danger allowances. Not all overseas assignments are in pleasant places. Companies offer an allowance or bonus to expatriates who relocate to countries where living conditions are difficult and/or dangerous.7 These allowances may range from 5% to 25% of base pay. The Department of State maintains a list of hardship posts and the attendant differential. The criteria used by the State Department is:

  1. Extraordinarily difficult living condition, such as inadequate housing, bad transportation, or difficulty obtaining proper food.
  2. Excessive physical hardship, such as climate or altitude.
  3. Unhealthy conditions, such as poor sanitation, disease, or lack of health facilities.

Information from the U.S. Department of State can be obtained from travel.state.gov/travel/cis_pa_tw/tw/tw_1764.html.

Automobile allowances. When an Australian Human Resource Director was asked his most vexing problem, he immediately replied, "automobiles." While automobiles are supplied to a limited number of employees in the U.S. (usually sales personnel and executives), it is common practice to supply automobiles to a wide range of employees in other countries. The problems associated with buying and selling automobiles, obtaining insurance and other factors, lead many companies to provide the expatriate, particularly at any executive level, with an automobile. In some countries, this extends to a driver as well – especially where custom, road conditions, and driving practices make driving oneself dangerous.

Other allowances. This section on allowances is not meant to be exhaustive of the costs that are typically incurred in sending an employee overseas. For example, there are a whole series of costs, such as work permits, that are associated with being able to have the expatriate work and live in the host country with his/her family. There are also special circumstances that are dictated by local customs, such as club memberships. All these need to be learned, preferably before the assignment, in order to understand the true cost of the overseas assignment.

Purchasing Power

Since the purpose of compensation programs for expatriates is to "keep employees whole," anything that negatively affects their standard of living needs to be taken into account. This section deals with three factors that can both decrease the expatriate's standard of living and also create a lot of uncertainty and confusion. Two of these factors, currency and inflation, are based upon the host country and the last, taxes, is based upon U.S. law.

Currency. The differences in the cost of living discussed in the section above depend partly on the exchange rate as of a particular date. When setting the actual differential it should be re-calculated based upon the exchange rate at that time. Information on exchange rates can be found by going to www.bloomberg.com/invest/calculators/currency.html.

Inflation. When something costs more each time you purchase it, you are a victim of inflation. We get particularly concerned when our income does not rise equivalently and our standard of living declines, because then we are unable to purchase what we used to. Expatriates encounter this problem, as inflation is not the same in all countries. For example, if an expatriate is transferred to a country with a high inflation rate while in the U.S. there is a low inflation rate, the pay that the expatriate receives will decline, sometimes rapidly, in the host country. Figure 22-2 shows the difference in inflation rates between the U.S. and Mexico during the 1990s. While these differences are large and would require action by the company to keep the expatriate "whole," they are not as extreme as the inflation rates in the mid 1990s in Russia (800-900%) or some of the other nations of the former USSR (1,500-2,000%).

A COMPARISON OF INFLATION RATES BETWEEN THE U.S. AND MEXICO IN THE 1990s
YEAR MEXICO U.S.
1992 16% 3%
1993 10% 3%
1994 7% 3%
1995 35% 3%
1996 34% 3%
1997 21% 2%
1998 16% 2%

Source: World Bank Indicators

Figure 22-2. Inflation rates, Mexico and the U.S.

In order to adjust for these changes in exchange rates and inflation over time, companies need to review and change their cost of living allowances. Since there are two variables here, exchange rate and inflation, either one or both can move for or against the expatriate's advantage. How often changes should be made is a matter of judgment. The most common rule is to re-calculate the cost of living allowance when it appears that there is a change of 5% or more. It may be useful to compare a portion of the expatriate's expenses to the prices of the same items in the home country.

One method of easing the concerns of volatile exchange rates and inflation is to use a split payroll for the expatriate. In this arrangement, a portion of the expatriate's pay is paid in U.S. currency to a bank in the home country. A second portion is distributed to the employee in the host country. The split should reflect the amounts that the expatriate is spending in the host country for living there and the amounts spent in the home country for maintaining the home, sending children to college, etc. This technique can also help to ease the equity problem between the expatriate and the local employees, if only a portion of total pay shows up on the host country payroll. Lastly, there may be some tax advantage if the host country taxes only the portion the expatriate receives in the host country. However, countries are becoming much more aware of this and are requiring expatriates to disclose all income received.8

Taxation. Most countries of the world have an income tax. This tax varies in amount and structure from country to country. Countries levy this tax on expatriates working there. Therefore, the company and the proposed expatriate need to obtain information about the income taxes in the host country. This should be done by contacting a qualified tax consultant. If this meant merely finding out about the tax structure in the host country and comparing it to what the expatriate would pay in the U.S., this would be a relatively simple problem. However, the U.S. tax code makes this much more difficult by also taxing the income of the expatriate. Using one of two sections of the IRS code, section 901 or section 911, ameliorates the effects of this "double taxation".9

Section 901 minimizes double taxation by establishing the following:

  1. If U.S. tax is greater than the host country tax, then the expatriate pays the difference to the U.S.
  2. If the host country tax is greater than the U.S. tax, then the expatriate has a tax credit which can be carried back two years and forward five years. Alternatively, in lieu of the credit, the expatriate can deduct foreign taxes paid on income that is subject to U.S. tax as an itemized deduction on their Form 1040, Schedule A.

In contrast, section 911 allows the expatriate to exclude up to $87,600 (in 2008) of foreign earned income from U.S. taxation(updated for cost of living each year), plus a housing allowance. Which of these two alternatives is better depends upon the particular circumstances of the expatriate and the assignment. Generally, the difference between the U.S. tax rate and that of the host country is a determinative factor. If the U.S. tax is greater than the host country's tax, section 911 will usually lead to a lower total tax liability. Section 901 is preferable when the U.S. tax is lower than the host country tax. Further information can be obtained at: www.irs.gov/pub/irs-pdf/p54.pdf.

In either case, the expatriate faces paying more taxes than if not on an overseas assignment. Companies make up for this difference in one of two ways. Both of these approaches start with creating a hypothetical U.S. tax liability of what the employee would have paid in taxes if not on a foreign assignment. The first approach is tax protection. In this approach the company reimburses the expatriate for the difference if the actual U.S. tax plus the host country tax is greater than the hypothetical tax calculation. If the two are less than the hypothetical tax calculation, the expatriate gets to keep the difference.

The second and more often used approach is tax equalization. In this approach the company pays both the U.S. and host country taxes for the expatriate. The company calculates the hypothetical tax and makes the deductions from the person’s paycheck on that basis. If the actual tax is less, the company reimburses the expatriate for the over-deduction. If the actual tax is more than has been deducted, then the expatriate reimburses the company for the difference. Tax equalization has two advantages. One is obviously that expatriates do not benefit from differences between actual and hypothetical taxes. The second is that location does not influence how much an expatriate can pocket, making transfers between locations easier.

Benefits

In expatriate compensation, there are no special benefit plans separate from the home country plan. There are however, adaptations and changes to domestic plans to accommodate the overseas experience. This section will examine the basic benefit areas.

Required Benefits. Expatriates are subject to all U.S. federal laws but not U.S. state laws in regards to benefits. Thus, expatriates pay Social Security but are not covered by unemployment insurance or Workers' Compensation. In some cases, it is useful for a company to take out special Workers' Compensation insurance to cover expatriates.

Expatriates are subject to the required benefits of the host country. These may vary from much less to much more than U.S. required benefits. A complete description of required benefits by country can be found at: www.socialsecurity.gov/policy/docs/statcomps/supplement/2008/5m.html

Since almost all countries have Social Security programs, expatriates can find themselves paying into two countries' programs. The U.S. has recognized this and for some countries has an agreement that does not require that the expatriate pay into the host country plan.10 These agreements can be found at: www.socialsecurity.gov/international/agreement_descriptions.html

Discretionary Benefits. In the U.S., the two major discretionary benefits are retirement plans and health insurance. Retirement plans ordinarily do not need to be adapted for expatriates. Medical plans may have to be changed or adapted, however, for expatriates. Many medical plans, especially HMO's, are limited in the geographical region to which they apply. In this case, a special medical plan needs to be initiated to cover the expatriate and his or her family. It should be noted that while these two benefits are discretionary in the U.S., they may not be in the host country. For instance, in Australia a superannuation plan (for retirement) is required for all employees. Also in many European countries, such as the United Kingdom, there is a national medical plan.

Pay for time-not-worked. The home country vacation and holiday schedule is a starting point in developing this benefit for expatriates. First off, holidays differ in when and how many there are in each country; all official holidays should be given to the expatriate. Further, these holidays are usually established by law and must be paid holidays. For country-by-country information on holidays, see www.earthcalendar.net/index.php. Vacations may also vary by country and are sometimes required by law. In many countries the number of days exceed those typical in the U.S.

Two special leave requirements are common for expatriates.

Home leave. This benefit enables the expatriate, and family, to come home on their vacation. This requires the company to pay the transportation costs of the family to and from the U.S. The amount of time may or may not coincide with the expatriate's earned vacation time. The longer the overseas assignment, the longer the home leave.

Rest and relaxation leave. This type of leave is especially important in hardship assignments. To be able to go into an area that is safe and familiar for a short period of time helps the expatriate withstand the rigors of the assignment.

The Balance Sheet Approach

Companies need a way of bringing all of the factors discussed in this section together in a program. The most common way is called the balance sheet approach, which obviously borrows from accounting where debits and credits must match. The purpose of the balance sheet approach is twofold. The first is keeping the expatriate whole. This idea relates to how the expatriate's living standard compares to life in the home country. The second purpose is to control costs. It should be clear by now that sending an employee overseas is an expensive proposition. Compensation experts estimate it costs close to $1,000,000 to send an expatriate family overseas for a year. Keeping these expenses under control is an important goal. There is also an underlying assumption in the balance sheet approach, which is that the expatriate is on a time-limited assignment and expects to return home.11

The balance sheet approach starts with setting the pay rate for the job. This may be from the company's internal job evaluation system or it may be set in terms of the market rate for the job. (See ERI's Salary Assessor software.) This pay rate is then divided into the following categories:

  1. Housing and Utilities
  2. Goods and Services
  3. Discretionary Income
  4. Taxes
This is a hypothetical allocation based upon information about living costs in the home country. (See ERI's Relocation Assessor software.)

The next step is to estimate the costs for these same categories in the host country. The amount of these categories for the host country minus the amounts for the home country is the allowance for that category.

This is illustrated in Figure 22-3 below.

James Callaghan is being transferred from headquarters in Chicago, Illinois to Madrid, Spain. He has a wife and two children. They can expect to rent a 1,600 sq. ft. apartment in Madrid. He will have one car while stationed there. The market rate for the position, Accounting Manager in Chicago is $97,368 (ERI's Salary Assessor software, 01/2010). The overall U.S. tax rate is 25.5% and is 50% for Spain.

Illustration of the Balance Sheet Approach
Category Chicago, Illinois Madrid, Spain Differentials
Consumables $19,713 $24,488 $4,775
Transportation $9,646 $13,513 $3,867
Health Services $2,458 $3,059 $601
Rent/ Utilities/ Insurance $34,310 $35,697 $1,782
Income + Payroll Taxes $21,889 $23,671 $1,782
Miscellaneous $9,352 $9,352 $0
Total Cost of Living $97,368 $109,780 $12,412

Source: ERI's Relocation Assessor® software (01/2010)

Figure 22-3. Balance sheet approach to comparing cost of living in different cities.

Alternative Approaches

Using the balance sheet approach does a good job of "keeping the employee whole." It doesn't do as good a job of keeping costs down. Further, being a mechanical process, the expatriate has little say in what he or she receives. So there is a search for other ways to compensate expatriates that are cheaper and not as complicated.12

Negotiation. Negotiation may be the simplest. In this approach the employer and employee negotiate a mutually satisfactory compensation for the assignment. If the costs are accurately presented, this can be an effective approach. This approach can be time consuming and can lead to inconsistent results. If large numbers of expatriates are involved, this approach is probably impractical.

Lump summing. A second approach is lump summing. In this approach a lump sum is provided to the expatriate to spend as he or she wishes. The lump sum is the combination of all the items in the balance sheet approach. This can be broken down into lump sums for pre-departure, at-post and repatriation.

Flexible compensation. A third approach is flexible compensation, also called a cafeteria approach. In this approach a total amount is established and all allowances can be changed depending upon the needs and desires of the expatriate, i.e., opting for a smaller apartment, but more money for schooling.

Localization. As this approach suggests, localization involves setting the compensation program in line with local national employees. This approach is most often used with new employees. Usually some adjustments are made for large differences in compensation or conditions from the home country. More and more organizations are looking at this type of plan.

One thing that seems to make sense is to reduce the allowances over time, at least for certain types of allowances. As one becomes used to living in a country, one should learn to live more like the locals. For instance, a U.S. expatriate living in Australia found that beef was very expensive. After awhile, he found that lamb was much cheaper than beef (and in fact much cheaper than either beef or lamb in the U.S.). An advantage of this approach is to get the expatriate out of the insulated arena in which many expatriates live and into the local culture.

THIRD COUNTRY NATIONALS

Thus far the discussion in this chapter has been of transferring a U.S. employee to a foreign assignment. But what about a U.S. company with operations worldwide transferring an employee from Belgium to Singapore? This transferred employee is called a third country national (TCN). A variation on this is a reverse expatriate: someone who is a citizen of Belgium transferred to the U.S., the home country of the company. The process of determining the compensation package for TCNs is quite similar to that of U.S. expatriates. Each of the parts, while basically the same, have some differences that need to be taken into account.

Equalization to Where?

The basic difference of compensation plans for TCNs is the question of "equalization to where?" There are four alternatives.

Host Country Equalization

This is paying a TCN the same amount that a local country national would be paid. (See the next major section of this chapter.) Sometimes there is a guarantee that TCNs do not suffer a reduction in salary from their present status. They would, however, benefit from any increase that the new assignment would generate. It is necessary to maintain a "shadow salary" based on the home country salary to calculate benefits and to determine what to pay the TCN upon returning home.

Headquarters Equalization

This type of equalization treats TCNs as if they all worked in and are citizens of the headquarters country. This has the advantage of internal consistency, as all people working in a country receive the same compensation package. Explaining the tax equalization may be somewhat difficult, however. This alternative can produce a compensation package substantially below or above the TCN's current one, making either recruitment or repatriation difficult.

Home Country Equalization

This alternative means paying TCNs their regular home country compensation package. Then a housing allowances is added if the cost of living is higher in the country where the employee is being transferred. Thus the housing allowance would be a comparison of Belgium to Singapore in the example above. This approach also maximizes the problem of internal equity in the host country. These problems are dealt with in the discussion below.

Modified Home Country Equalization

This final approach uses the home country method for calculating living costs but uses a headquarters approach for calculating base pay. This approach works best if the company uses a split pay system. Otherwise TCNs from different countries would still be receiving different paychecks.

Base Pay

Current base pay of a TCN may vary from being about the same as the U.S. salary for the position (e.g. expatriate pay Europe) to considerably below that of the U.S. (e.g. expatriate pay in Africa). If the base pay is set as it would be for a U.S. expatriate, the TCN would receive a large increase making it very difficult to get him or her to return "home." On the other hand, setting the base pay according to the value of the job in the TCN's home country means very low pay if the TCN is transferred to a high wage country.

Another problem with base pay is knowing what the base pay for the job is in the TCN's home country. Obtaining wage rates for most countries outside the U.S. is very difficult, as will be discussed in the section on local country national compensation.

Variable Pay

In the U.S., variable pay in the form of performance based pay and bonuses is well accepted. But employees from other cultures may see this differently. In some cultures, security is very important and variable pay seems a very scary position. In addition, bonuses are common in many countries but are not performance related; they are an expected part of being an employee of the company. So relating the amount to performance, particularly individual performance, may seem strange to some TCNs.

Allowances

Determining the cost of living for TCNs can be done in the same way as for U.S. expatriates. ERI's Relocation Assessor® software can be used to compare two international locations.

Taxes

The tax situation should be simpler between two foreign countries since the U.S. is the only country that creates the "double taxation" problem. The income tax can be calculated for each country. If the total is higher in the host country, the TCN can be given an allowance.

Benefits

As will be seen below in the discussion of local country nationals, benefit programs differ considerably throughout the world. Like all expatriates, TCNs retain most of the benefits of their home country. But where one country has a benefit and the other does not, the company may need to add this to the TCN's compensation package. The most obvious difference that comes to mind is a TCN transferred from a country with a national health system to the U.S. The company would need to provide this expatriate with private health insurance coverage.

LOCAL COUNTRY NATIONALS

Three interrelated factors seem to create the considerable differences that appear in pay practices – the economy, laws and culture. The wage level of countries varies greatly with the degree of development of the economy. With the exceptions of minimum wage and equal pay, the U.S. government stays out of wage setting. This is not true in other countries. Many countries control wages through an incomes policy, although with globalization this is declining. Some countries have wage boards or councils that set national wage rates for a wide variety of jobs in the country. Others encourage national wage rates through collective bargaining. Culture affects pay practices in many ways. For instance, the Japanese culture, which values cooperation over competition, is not a fruitful environment for individual incentive programs. In this section these forces are examined for their impact on a compensation program.

A Note on the Employment Relationship

The employment relationship is a contract or at least has many of the aspects of a contract. Each party contributes something for which they expect something from the other party. The employee contributes time and effort in exchange for pay and other compensation. In the U.S. the legal and cultural base for the employment relationship comes from the common law doctrine that states that employment is "at will." This means that the employer may fire the employee for any reason, a good one, a bad one or none at all. This right has been eroded over the years, first by unions, then by laws (mainly civil rights laws) and more recently by the courts using the doctrine of implied contract. Today it is increasingly difficult to fire someone except for cause or economic exigency.

Not all countries derive their definition of the employment relationship in the same way as the U.S. In countries with a civil law system, employment rights become a part of civil rights. In these countries the culture, backed up by law, dictates that the employee has (or obtains over time) an interest in the job. This means that removal from the job is more difficult and costly. For example, Mexico has an acquired right law. Under this law employees attain a right to compensation practices that have been in effect for two years.

In addition, the government is a player in the relationship. The employment relationship is seen as affecting the larger society and the economy, and is thus a subject for laws and regulations that are perceived as for the greater good.

Base Pay

It is certainly no surprise that organizations in different countries vary greatly in how much they pay for a particular job. The reasons for this can be categorized into internal business factors, differences in prosperity and purchasing power, and social factors.13

Business factors relate to the type of business being conducted and the organizational policies that are used to carry out the business. Some companies are more sensitive to wages where the product or service makes the company labor intensive. In addition, there are differences in productivity that have to do with both the capital equipment and the skill level of employees. Organizational strategies may focus on granting employees security in return for lower wages or vice versa.

The level of the economy in general will affect wage rates. Prosperous countries will pay higher wages. But this can be deceiving. A country may be prosperous but have high living costs, thus the employee's purchasing power is not as good as it would be in another country that has a lower cost of living.

Union and government influences on wages are greater in some countries than in others. New Zealand for many years had strong unions and a system of government wage setting all the way down to specific job titles. This program has been dismantled in recent years with dramatic effects on wages structures and programs. For instance, there has been a considerable rise in the use of variable pay.

Cultural norms also have a considerable influence on how effective pay programs can be. In Japan, an individually based performance and pay system would have trouble integrating with the collectivist spirit of the country. Also, the degree of uncertainty involved in variable pay may make it scary to the employee. Finally, egalitarianism calls for pay structures that have a narrow range.

Setting base pay is complicated in other countries because of the lack of information. In the U.S. we rely greatly on wage surveys to determine the appropriate wages or at least to set the wage level for the company. In other countries wage surveys are non-existent or the data is highly suspect. This situation is changing rapidly as globalization spreads to more countries. Still, obtaining accurate data can be very expensive. However, ERI's SalariesReview.com provides international wage rates at a reasonable cost.

On the other hand, setting base pay may be easier where governments set it. (In the past this was true of Australia.) A national commission sets wage rates “awards” for a variety of positions in these countries. This can be a mixed blessing; wages are taken out of competition in the country, but the company has little or no control over what is usually its largest expense item. Almost all countries have some form of minimum wage; however, these minimums may differ by location or job category.

Establishing a wage structure may be different from country to country, as well. The temptation is to take a job evaluation plan from the home country and apply it to the local situation. This can lead to poor results. The factors that are important in creating a wage structure in the home country may not be the ones that are important in the target country. Conceptually, wage structures can be based upon the person, the job, or performance. For example, in the U.S., the job and performance are the main criteria. While in Japan, the wage structure is built upon the person, and to a lesser degree, performance.

As is the case in the U.S., the supply and demand for labor affects wage rates and can upset the establishment of a wage structure using internal methods. In many South American countries, the large supply of low-skilled employees lowers wages to below poverty levels. On the other hand, the supply of professionals and top-level managers is so low that wage rates in these categories can exceed those of the U.S. Another example is in India, where the supply of trained professionals is high, driving wages for these people down. This may explain why almost 2/3 of the H1B immigrants come from India. In addition, cultural factors make some jobs more valuable in one country as compared to another. Health care professionals in the U.S. are paid better compared to those in almost any country in the world, while internationally, jobs occupied mostly by women are paid far less than those done by men. The point of all this is that each country has its own distinct wage structure that is an amalgam of economic, government and cultural factors.

One more difference is wage spread. In the U.S. the spread of wages from top executives to entry-level employees is immense, upwards of 1,000 to 1. While there are continuing concerns about top executive wages, this spread continues and will undoubtedly prevail. In contrast, most of the Pacific Rim countries operate on a 20 to 1 ratio that is considered appropriate. Countries like Japan and Australia value their heritage of egalitarianism. A large wage spread is discouraged in these societies. The government supports this position by imposing high tax rates on high wage rates.

Bonuses

Bonuses are common throughout the world. In fact, in some cases the law requires them. The most common situation is the payment of an extra month's pay at some time of the year, like at vacation or holiday. This is called the "13th month" wage. Companies need to be aware of this requirement or custom when they calculate labor costs, as this is not considered a variable cost. This bonus is not associated with either the individual's or company's performance, it is given as a part of the basic employment contract.

Variable Pay

American-style variable pay plans are less common in other countries, but their popularity is on the rise. Profit sharing varies from being an illegal practice to a legal requirement (Mexico). Culturally, some countries would find profit-sharing undesirable. Families or the government operate the major companies in many countries so that profit is less important than other goals or is kept a secret from everyone but the family.

Stock options have become very popular in the U.S. and are being applied to lower and lower levels of employees within the organization. But this assumes that the company is publicly traded and that the workers understand and have access to a stock market. In countries like Germany, Korea and Japan, companies are closely held, making the application of stock options impractical. A number of years ago, the author worked with a U.S. bank that had been bought by a Mexican bank. The new owners immediately dismantled a very successful stock option plan because the Mexican bank was not a publicly traded company and the management found the idea of profit sharing with employees distasteful. So even if your company uses stock options, the local employees may not respond to something they find strange. Lastly, the way stock options are treated for tax purposes in other countries may make them an unattractive incentive.

Pay for performance is also not as commonly used in other countries as it is in the U.S. This may be due to a reluctance to rely on performance appraisal as opposed to performance measurement. The judgments of managers seem less acceptable than the use of objective measures when evaluating performance. Further, the definition of performance varies in other cultures. In Japan, performance is a much more long-term evaluation of the employee, taking into account background and training, current activity and future promise. Despite all these caveats, it is clear that variable pay is on the rise throughout the world.

Allowances

The term allowances has a different meaning for LCN's than expatriates. In other countries allowances are additions to base pay given for a variety of reasons. They can increase an employee's pay by 20% or more. These allowances can individualize pay in situations where pay is set mainly through external sources such as the government or union contract. There can be a great many of these allowances granted for a variety of reasons, and they vary by country. For instance, in the Metal Trades Association Agreement in Australia, there are 56 separate allowances to which an employee may be entitled.

Despite the wide variety of allowances found, they can be categorized into position, behavior and person. Position allowances are the most common. They consist of aspects of the job such as shift work or poor physical working conditions. They may include added responsibilities in a job, such as training new employees. In Japan, this allowance is for supervision and is given to middle management--from section chiefs up to department heads. A second set of allowances, behavior allowances, are given for specific things an employee does or can do. An example is the attendance allowance in Mexico to try to reduce the high incidence of employees not showing up for work on a daily basis. The third category of allowances is personal allowances. These allowances have nothing to do with the job or what the person does on the job. They have to do with the person's circumstances outside the job. Examples of this type of allowance would be an allowance for each child in the family or an allowance for transportation for employees living a certain distance from work. In Thailand, married teachers are provided with housing for their family. Single teachers are expected to live with their parents.

Benefits

Benefits in countries throughout the world come in a wide variety, both in type and source. While we can use the categories of required and discretionary, each benefit can be quite different, and there are important benefits in some countries that are non-existent in the U.S. Understanding the benefit structure of each country in which the company operates is exceedingly important. Many benefits are required, and failure to implement them properly can lead to legal problems. Second, there is a matter of cost. In many countries the cost of benefits can be 50% or more of the base pay. Making the decision to locate in a country on the basis of base pay differentials can lead to major unexpected additional costs.

Required benefits. In the U.S. the two major benefits from the standpoint of cost are medical and retirement plans. With the exception of the requirement for Social Security payments, both of these are discretionary benefits. This is not so in most other countries; they are most commonly required benefits. The required benefits can be broken into the following categories:

  1. Old age, invalidity and survivors
  2. Sickness and maternity
  3. Work injury
  4. Unemployment
  5. Family allowance

The first category, old age, is most like our OASDI portion of Social Security. For many countries, particularly European, this is a more ambitious program, making it a major portion of the retirement plan of most workers in the country.

Sickness and maternity is like our Medicare but available to all people in the country, not just the elderly. This benefit replaces the expensive private medical programs in the U.S. That is the good news. The bad news is that this is usually a major cost required by law and at least partially paid for by the employer.

Maternity laws exist in almost all countries of the world and in general are much more extensive and liberal than in the U.S., particularly in the amount of time granted for maternity leave. Work injury and unemployment are much like our programs but ordinarily more extensive. Combining the sickness and work injury in some countries can reduce or eliminate the need for sick leave. The one category that is completely missing in the U.S. is family allowance. This category pays people an allowance if they have a certain size family.

Each country varies in how each of these categories is financed. In some cases the government pays the whole costs out of taxes. In others, the employer or the employee pays all or a portion of the costs. Some countries have laws that create a supplementary program in a particular category, most often it is a retirement plan requirement. Australia has such a requirement, as all companies must offer a superannuation plan to their employees. For a more complete description of a country's program see www.socialsecurity.gov/policy/docs/progdesc/intl_update/2005-09/.

An area of benefits not covered by the laws discussed above has to do with time off the job and working hours.

Time off. There are two types of time off the job: holidays and vacations. National holidays obviously differ from country to country, both in the number and dates. The number of days varies, and the U.S. is around the median in terms of the number of holidays. The exact holidays can be found at www.earthcalendar.net/index.php.

Vacation time in much of the world is more extensive than in the U.S. Most of Europe takes all of August off every year (to which American tourists traveling to Europe in August can attest). Four weeks is more common than the U.S. two-week vacation. Further, vacations are taken seriously in most countries. People do not work all year and carry over their vacation time; they take it during the summer months.

Working hours and overtime. While our 8-hour day, 40-hour week work schedule is relatively common throughout the world, there are many countries that have a different standard. Europe is moving to a schedule of less than 40 hours a week while much of Asia still works on a 6-day schedule of 44 or 48 hours. What is getting less common is the long break (siesta) in the middle of the day with extended hours of work into the evening. Overtime regulations vary between countries. The U.S. standard of time and a half for hours worked over the standard week's hours is the most common. However, some countries do not pay time and a half for overtime and some pay more. For instance, in Australia all Saturday hours are time and a half and Sunday double time regardless of the number of hours worked that week.

Termination. As indicated at the beginning of the discussion of LCN, compensation countries that use a civil law system make termination much more difficult. They not only restrict the grounds for dismissal and provide redress for violation, but they also provide liberal notice and grant the person severance pay. So termination of employees for any reason may be difficult and costly. For instance, in Europe the average termination costs to companies is 22 weeks' wages.14

Notice is intended to reduce the surprise of termination and allow the employee time to start searching for alternate employment. Each country varies in the amount of notice required, based upon:

  • Length of service
  • Basis of payment (hourly vs. monthly)
  • Occupational category
  • Age

The actual time required may vary from a single week to up to six months.

Severance pay is common for most countries. The rules governing this can be very complex. In some countries severance pay is seen as a type of retirement plan and may be required regardless of the grounds for dismissal. Most countries restrict severance pay where the grounds are misconduct. The calculation of the amount of severance pay may be fixed or vary with the length of service. The standard can vary from a week per year of service to a month per year of service with most countries toward the high end of the scale.

Severance pay can create a high contingency cost for the company, one that grows over the years, particularly if the work force is stable. It may be useful to establish a fund for paying this contingent liability. In fact, some countries require this. Finding information regarding termination requirements is difficult, but the International Labour Office has a digest on termination.15 This volume provides information on 72 countries throughout the world.

Discretionary benefits

This section discusses a wide range of benefits that are common in other countries. They are discretionary in the sense that they are based in custom and not in law. This is not to imply that the company can safely ignore this class of benefits. In fact, these benefits may be needed to attract local employees to work for your company. What follows is a discussion of some of the more common benefits that can be found in countries. This is nowhere near a complete list.

Transportation

One of the more common benefits in other countries is the provision of an automobile to employees above some level in the organization. This can be a very complex issue, with the class of automobile going up with the level of the person in the organization. It is a situation made for corporate politics. This practice got started for two reasons. The first is the cost of automobiles, which in other countries can be 2 to 4 times that in the U.S. The second reason is the taxation policy of some countries that treats automobiles as an expense to the company; the employee does not pay taxes on the use and maintenance of the automobile. As countries have begun to tax this benefit, it is becoming less attractive. For lower-level employees, companies commonly subsidize their public transportation.

Meals

When in Indonesia, I was going out to lunch with an acquaintance who had a small office with four employees. Before we left, he made sure that all his employees had ordered a lunch, and when it was delivered, he paid for the meals. I asked about this and he said that this was a common benefit in Indonesia. In Mexico, it is common to provide lunch vouchers free or at substantial discount to employees. This benefit seems to be a function of the level of the economy. It is not common in highly developed economies. While in less developed economies, benefits may also include the provision of hard-to-obtain supplies.

Loans and Taxes

In countries where the banking system is not highly developed or is an instrument for the upper echelons of the country, it may fall on the employer to help out employees with low interest or no interest loans at times. This may be particularly true in countries where adequate housing is a problem. In some countries part, or all, of the employee's income tax is paid by the employer. The most common procedure is to pay the tax due on benefits.

Executive Perquisites

While pay for U.S. executives is clearly above that of most other countries, the perquisites of the job may not be as great. One executive at a power company in the Pacific Rim received perquisites that helped make up for the lower pay. These included a house with servants, a car and driver for himself and his wife, a liberal expense account that took care of most household expenses and one for his wife for entertaining, and vacations in various locations throughout the world. Things like this need to be kept in mind if the company is hiring local executives in some countries. Figure 22-4 shows the breakdown of a Chief Executive's compensation package in New Zealand.

CHIEF EXECUTIVE COMPENSATION PACKAGE
Item New Zealand
% of Total
Compensation
Base salary 60.0
Bonus 4.0
Other Cash Items 2.0
Transportation 13.0
Housing and Loans 1.5
Insurance (Including Medical) 0.6
Other Benefits (Club Fees, Telephone) 2.3
Superannuation (Pension) 6.6
Fringe Benefit Taxes 10.0

Source: T.J. Atchison, "Impressions of Compensation in the Pacific Rim," Research in Personnel and Human Resources Management, Supplement 2, (San Francisco, Jai Press, 1990)

Figure 22-4. CEO compensation package, New Zealand.

THE MULTI-NATIONAL COMPANY (MNC)

This chapter has thus far assumed an international company, that is, one that has a home base with operations in other countries of the world. This is what creates the distinctions of expatriates, TCNs and LCNs. Globalization is changing how business organizations perceive themselves and the strategies that follow from this changed perception. As they move more and more of their operations to international locations, they emerge as an international corporation. In this process, there are several stages through which an organization will move:

  • Export stage. Business outside the home country is supported largely by trade. What few employees are needed overseas are generally expatriates in all but clerical work.
  • International stage. Manufacturing and some technology resources are located outside the home country. As organizations move from having sales offices in other countries to having production facilities, they see themselves as becoming multi-national corporations (MNC's).
  • Transnational stage. The business focus becomes multinational with emphasis on accelerating global business expansion. As MNC's grow and move to more and more countries, they take on characteristics of a trans-national corporation (TNC's). The difference may seem subtle, but a TNC loses its connection to any particular country and becomes a truly international organization. With this change comes a difference in how international employees are seen and handled for compensation purposes.
  • Global stage. The primary business focus is worldwide with management making its geographic business decisions in a borderless sense. This type of company has no real home country. It hires and develops staff from wherever in the world it finds the best talent. Its markets and operations are determined by economic decisions and not political boundaries. This type of company needs a much more integrated type of compensation plan than the diverse plans suggested in this chapter.

SUMMARY

As you can see, as organizations move from one stage to another, their international focus increases. In turn, this affects their human resources strategy for both expatriates and local nationals to help them achieve business goals.17

Certainly one of the long-term effects of globalization is that the factors that have led to the current techniques, the economy, culture and politics are converging and allowing for a more common approach to compensation plans in TNC's. Ideally, a compensation plan that would reinforce this vision would be a common plan for all employees, without regard to where they had come from or where they will next be assigned.18 There are places where these differences are narrowing and companies are learning to at least regionalize their compensation plans. Europe and South America are places presently that provide a laboratory for trying out new compensation plans.


1 T.I. Friedman, The Lexus and the Olive Tree (New York, Doubleday & Co. 2000).
2 J.J. Martocchio, Strategic Compensation (New Jersey, Prentice-Hall, 1998).
3 F. McGoldrick, "Expatriate Compensation and Benefit Practice of U.S. and Canadian Firms: Survey Results," International Human Resource Journal, Summer 1997.
4 Oemig, D., "When You Say 'We'll Keep You Whole' Do You Mean It" Journal of World Business, Vol.32 #2 1997. Pp. 118-133.
5 Lowe, K., Millman, J., De Cieri, H., & Dowling, P. "International compensation practices: A ten-country comparative analysis," Human Resource Management; Vol. 41 #1 Spring 2002.
6 R.J. Stone, "Compensation: Pay and Perks for Overseas Executives," Personnel Journal, January, 1986.
7 W.J. Hibbitt and T. Dwyer, "Keeping Expatriates Out of Danger," International HR Journal, Fall 1998.
8 Grensing-Pophal, L., "Expat Lifestyles Take a Hit: the decline in the dollar's value against foreign currencies has forced employers to explore their options when staffing facilities worldwide," HR Magazine, March 2008.
9 S.M. Kates and C. Spielman, "Reducing the Cost of Sending Employees Overseas," Practical Accountant, 1995.
10 L. Hudson, "What U.S. Expatriates Need to Know About Social Security," International HR Journal, Winter 1999.
11 Wilson, L., "The Balance Sheet Approach to Expatriate Compensation: Still with Us After All These Years," Expatriate Observer, Vol. 23 #4, fall 2000.
12 Wentland, D., "A New Practical Guide for Determining Expatriate Compensation: The comprehensive model," Compensation and Benefits Review; Vol. 35 #3 May/Jun 2003.
13 E. Logger, R. Vinke and F. Kluytmans, "Compensation and Appraisal in an International Perspective" in A. Harzing and J. Van Ruysseveldt, Eds. International Human Resource Management (London, Sage Publications, 1998).
14 H. Mosely, "Employment Protection in Europe," InforMISEP, Winter 1993.
15 Termination of Employment Digest (Geneva, International Labour Office, 2000).
16 Bloom, M. & Milkovich, G. "A SHRM perspective on International Compensation and Rewards," Research in Personnel and Human Resource Management, 1999.
17 Sheridan, W., & Hansen, P., "Linking International Business and Expatriate Compensation Strategies," ACA Journal, Vol.5 #1, Spring 1996.
18 Watson, B., & Singh, G. "Global Pay Systems: Compensation in Support of a Multinational Strategy" Compensation and Benefits Review; Vol. 37 #1, Jan/Feb 2005.

Internet Based Benefits & Compensation Administration

Thomas J. Atchison
David W. Belcher
David J. Thomsen

ERI Economic Research Institute
Copyright © 2000 - 2013

Library of Congress Cataloging-in-Publication Data

HF5549.5.C67B45 1987 658.3'2 86-25494 ISBN 0-13-154790-9

Previously published under the title of Wage and Salary Administration.

The framework for this text was originally copyrighted in 1987, 1974, 1962, and 1955 by Prentice-Hall, Inc. All rights were acquired by ERI in 2000 via reverted rights from the Belcher Scholarship Foundation and Thomas Atchison.

All rights reserved. No part of this text may be reproduced for sale, in any form or by any means, without permission in writing from ERI Economic Research Institute. Students may download and print chapters, graphs, and case studies from this text via an Internet browser for their personal use.

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