Expatriate Compensation in the International Context

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Table of Contents

Introduction
Literature Review
Conclusion and Recommendations
References

Introduction

The compensation has long been established as a primary means of fostering loyalty and productivity of international expatriates. Nevertheless, the HR managers continue to face several challenges when implementing it which ends up in loss towards the organizations. Evans, Pucik and Barsoux, (2010) has elaborated that the issues that gave birth to international human resource management remain more important than other functional areas is expatriation and adaptation of practices to different cultures.

The challenges posed by transferring the employment of an executive to a foreign-based company are many and are not easily solved. The aim of the current report is to outline the factors that affect the compensation process, review the most popular approaches, and determine if they address the issues comprehensively. If the differences between the methods and the needs could be found, a set of recommendations to improve the current HR practices will be formed that will offer useful insights on the matter.

Literature Review

Factors Affecting Expatriate Compensation

The most often mentioned factor that influences the expatriates satisfaction by the compensation strategies is the differences in cost of living between the host and parent country (Nazir, Shah, & Zaman, 2014). If the cost is higher, the employer is required to adjust the compensation package in order to merge the gap. In the opposite situation, the difference is not subtracted. Such approach is known as a no loss policy and occurs with slight variations in the majority of the HR practices.

The most difficult part of addressing this factor is the assessment of the gap. However, with the growing trend of the multinational business practices the need for a universal approach has emerged, so some attempts have been made to present an analysis that would allow the calculation of the cost of living (Mishra, Singh, & Sarkar, 2012).

Nazir et al. (2014) point to a growing body of evidence that expatriates expect from their company to assess the trends of goods and services in the host country and incorporate the results in the compensation package, and that the supplementary cost of living is adjusted so that the employees are left in either equal or a better position compared to that of the parent country.

The presence of expectation can be viewed as a form of physical contract a set of beliefs that form during the initial phase of the agreement and is equally important for the successful retaining of the personnel (Tornikoski, 2011). Thus, the factor can be viewed as a combination of financial, or tangible reward, and the expatriates perception of the HR practices, known as the intangible particularistic reward, or IPR (Tornikoski, 2011).

Cultural influences

As gradually more companies establish subsidiaries in other countries, and for some of the multinational corporations it is not uncommon to have expatriates in many parts of the world at once, cultural issues become visible as part of the working environment. The unaccounted cultural influences possibly result in two outcomes: the lack of mutual understanding on the individual level and the incorrect perception of the companys policies and strategies.

For example, the some of the benefits highly appreciated in one culture may be deemed inappropriate in another (Mishra et al., 2012). Both issues eventually result in the decline of healthy workplace climate and weaken expatriates satisfaction with their position. While the individual plane of co-worker and subordinate relations can be addressed by compensation packages only partially, taking into account the values and beliefs that define the attitude towards rewards and benefits must be considered in localizing the compensation packages. Mishra et al. (2012) outline the most common ways of identifying and targeting the cultural issues in HR compensation practices.

The most common and efficient one defines the culture as belonging to a certain cluster, based on the language group or other parameters. The package is then formed in accordance with the known set of principles shared by all the cultures of the cluster. The authors also specify five cultural dimensions that demand attention in the compensation process (Mishra et al., 2012).

Power distance: level of inequality between workers which is perceived acceptable. In some cultures, even a slight discrepancy is unethical, while in others the cultural norms allow noticeable inequalities.

Individualism and collectivism: depending on the established norms and traditions, the individual effort may be valued higher than that of the group. The collective effort also may differ across cultures as grounded in corporate or family ties. The incentives and bonuses should be assigned accordingly to reward individual or collective achievement to appeal to the preferable mindset.

Masculinity and femininity: the cultures which value competition and differentiate the social roles based on gender are characterized as masculine and tend to favour male employees, which can be observed in reward policies. The feminine cultures are less biased and provide a more objective financial incentives.

Uncertainty avoidance: the predisposition towards structured and predictable models. The cultures that have stronger uncertainty avoidance favour the security and stability and lean towards the well-defined and established reward schemes, whereas the low uncertainty avoidance suggests the emphasis on the achievement, healthy workplace climate, and ethical values. Such preferences are noticeably correlated with the concept of tangible and intangible rewards utilized by Tornikoski (2011). The regulated and well-thought out financial incentives are the core of the tangible universal rewards (TURs) while the subjective and psychologically defined values of low uncertainty avoidance cultures fall within the intangible particularistic category.

Confucian dynamics: prioritizing short-term goals over long-term ones and vice versa. The compensation package needs to be formed with these in mind, as certain rewards will be under-appreciated. For instance, the society which has little interest in the long-term prospects will not appreciate the retirement benefits.

Taxation

Another major factor that seriously complicates the expatriation process and thus demands to be included in the compensation package is the uneven taxation. The issue presents a bigger challenge in part due to its partial connection into the legal system: while the majority of the rewards lie mostly within the domain of business ethics and labor law, the taxation demands attention at legal levels and its more difficult to address.

One of the more common examples is the situation where a parent-country national working in a host country is subject to taxation from both jurisdictions: the host country bases the claim on the source of income while the parent one on the citizenship/resident status. However, many countries establish bilateral income tax treaties which either eliminate or decrease the tax paid to one of the countries (McNeil, 2013).

Naturally, the countries with more favourable conditions are more attractive for the expatriates, leaving other possible partners at a disadvantage. In addition, some scenarios, such as the multiple transfers of an employee across several countries, create additional insecurities, as the expatriate may be eventually excluded from each countrys benefits policy despite theoretically complying with the companys requirements. McNeil (2013) also points to an even more complex situation where the benefits are payable in stock options.

In the case of the expatriate working in a subsidiary company in the host country is issued a nonqualified stock option by the parent country, receives the option in the host country, and decides to exercise the option in the country other than the host or the parent, the setting demands three separate calculations of the securities law requirements need to be made to report the taxable income. The matter may also be complicated with time restrictions issued by each country regarding the execution of the grant related to the date when the grant was issued and executed.

Several approaches exist in HR managerial practices that address these issues, with tax protection and tax equalization being the most common (Nazir et al., 2014). The former covers the difference in taxation if the host countrys taxes are greater than the hypothetical taxes the expatriate would pay in the parent country, but does not cover the opposite situation. The latter, on the other hand, guarantees that the employee pays the exact same amount, even when the actual taxes of the host country are lower.

Key Components of Compensation Program

The compensation of the expatriates has some similarities compared to local HR approaches but has a number of differences in each key component. For example, the base salary, a central concept in the financial reward setting, describes the fundamental element of a compensation package, which is then expanded with the set of allowances, such as housing allowance, cost of living allowance, and foreign service premiums, among others. The majority of allowances and benefits are connected to the base salary directly, while for domestically employed staff it serves as a benchmark that defines the amount of benefits and bonuses (Nazir et al., 2014).

Depending on the approach to the compensation package, the base salary can be derived from the equivalent of their parent country or estimated from the amount paid to the local employees. The two most common premiums paid to expatriates (mostly parent-country nationals) are hardship premium and foreign service inducement. The former is meant to account for the difficulties associated with the move and adaptation on the initial stage of the assignment while the latter is aimed at decreasing the unwillingness of accepting the task and is usually presented as a percentage of the base salary or as a one-time payment of a certain sum of money.

Finally, a number of allowances are included to compensate for the differences in the expenditures between the parent country and host country, with two most noticeable being the cost-of-living and housing allowances. The former takes care of the possible differences in such fields as medicine, transportation, and domestic help, while the latter provides employees with means of maintaining their quality of life standards.

The company either provides the housing to the expatriate or includes the expenses associated with it to the compensation package. Less frequent but still fairly popular allowances cover trips to the home country to maintain the expatriates business and family ties (home leave allowance), covering costs of education for their children (education allowances), transportation costs, both inbound and for the move to the host country (relocation allowances), and compensating for the loss of income by the expatriates spouses, either by issuing one-time payments or by providing job opportunities in the host countries (spouse assistance).

The family status is one of the key factors in determining the balance between the allowances while compiling the compensation package. Single employees often focus on the challenges associated with the move and the taxation issues, so their package needs a more prominent hardship premium and tax equalization. Married couples who do not have children show more concern regarding salaries and cost of living allowances, so these must be prioritized. Families that have children retain the need for COLAs, but the scope of the requirements usually broadens to include education and transportation costs, among others. Besides, the relocation is obviously more challenging for them, so the requirement for the hardship premium returns. Finally, the older executives value salaries and COLAs as it allows them to maintain the way of life they are accustomed to (Nazir et al., 2014).

Approaches to Expatriate Compensation

Since it is clear that the components of the compensation are multiple and require thoughtful balancing depending on the setting, several approaches have been created in an attempt to create a standardized and comprehensive practice.

Balance sheet approach

This is one of the most common methods of expatriate compensation. According to Nazir et al. (2014), the balance sheet approach is the one used in the overwhelming majority of the multinational corporations. From the financial perspective, it aims at maintaining the purchasing capacity of expatriates while providing them with the additional incentives to raise the attractiveness of the relocation (Mishra et al., 2012).

Generally speaking, it includes all of the key components mentioned in the previous section to address all possible expenditures faced by the expatriate. The base salary is also maintained at the level of his parent country. The employee does not suffer from the downside of the move and is able to retain the usual lifestyle. It establishes equity between the expatriates and the home-based employees and maintains the attractiveness of the assignments regardless of the destination country. On the other hand, it creates major differences between the parent-country nationals and host-country nationals working at the same firm (Mishra et al., 2012).

This is most common among in the countries which serve as hosts to subsidiaries of the companies with higher base salaries: the HCNs may perceive the higher salaries of the PCNs as unfair and discouraging. The opposite effect is also possible when the host country has higher salaries than the parent one. In this scenario, the parent-country expatriates are at a severe disadvantage: they get the incentives and salaries that are deemed high in their country but are left underpaid compared to the HCNs working with them.

Finally, the approach is highly attractive as it promptly illustrates the benefits for individual expatriates, creating a feasible psychological contract (Tornikoski, 2011), but presents the challenge in administering it, especially in the setting with taxation complications such as described above or other unfavourable government fund transfers.

Going rate approach

This method may be viewed as the polar opposite of the balance sheet approach. The central difference is the base salary, which is based on the host countrys rate. However, while the balance sheet approach mostly uses the rates of its parent company as a benchmark, the going rate approach can use one of the three rates: the salary of host countrys locals, the one of the expatriates in the same field, or all of the similar subsidiaries rates.

On the first glance, the approach addresses all the disadvantages of the balance sheet method: there is no difference between the locals, host-country nationals, and the parent-country nationals, so the equity is maintained. For the expatriates from the parent countries with lower salaries, this is also attractive as they gain an advantage over their home-based co-workers, while in the opposite case the company usually adds the incentives to compensate for the difference (Mishra et al., 2012).

However, the benefits are uneven. First, the assignments to different countries will differ in financial attractiveness. Second, the higher salaries during assignment may result in the unwilling to return to the parent country. Third, the equity between employees of the company is disrupted, partially because of the differences in payment for each assignment. As the principles of the going rate approach are easy to understand, it is almost certain that the rivalry for the more favourable positions will emerge soon.

Interestingly, while the majority of advantages and disadvantages are switched with the change of the payment principles, one major disadvantage is shared by both approaches: the vulnerability to taxation (McNeil, 2013). In addition to the administrative differences that mostly impact the HR managers, the taxes are more likely to affect the employees salaries. As a result, the assignments in countries of similar levels of economic development may provide sufficiently different outcomes for the expatriates.

Destination-based approach

Similarly to the going rate approach, this method also centers around the base salary characteristic for the host country. However, instead of using it as a benchmark, the suggested strategy is to adjust the PCNs incentives to be closer to those of HCNs (Nazir et al., 2014). It addresses several disadvantages of the going rate approach, primarily the gap in financial incentives. It also tries to find middle ground between the equity among the employees of the same subsidiary company and that among the expatriates taking different assignments. It also fosters identification with the host country, contributing to the healthy workplace climate.

However, it complicates the expatriate return process in the same way the going rate approach does (Nazir et al., 2014). Besides, it requires additional analysis of the local markets to adjust the base salaries properly, effectively removing the simplicity and perceived transparency of the process. This means, among other things, that assignments become less attractive on the initial stage, which in turn compromises the state of psychological contract and leads to low retention of the staff (Tornikoski, 2011).

Cafeteria approach

Unlike the previously mentioned approaches, which are used primarily for the mid-level managers, the cafeteria approach is applied to compensating the senior level expatriates whose income notably exceeds the base salary (Nazir et al., 2014). It is largely similar to the balance sheet approach in terms of incentives included. Its defining feature is the offering of a certain number of incentives to the employees. The incentives can include the companys car, insurance, free education, and a number of options that improve the expatriates quality of life, such as the club membership.

The number of incentives is limited, usually to two. Collectively known as flexible benefits, these incentives have several advantages. For the HR managers, they present the possibility of decreasing the cost of the compensation packages, which are traditionally expensive (Tornikoski, 2011), by eliminating unnecessary and undesirable incentives and allowances. For the expatriates, the possibility of choice presents an opportunity to utilize the allocated compensation in the most efficient or desirable way. This, in turn, strengthens the loyalty by fostering the state of psychological contract (Tornikoski, 2011).

Total Reward Package

Tornikoski (2011) argues that while the compensation process is widely recognized and ubiquitous, it fails to foster the commitment of the expatriates, and results in low staff retain rates. The reason for this is the focus on the tangible reward which not quarantine the loyalty. All of the recognized key factors and most of the approaches collect and cater the financial incentives and ignore the more subtle intangible particularistic rewards.

These range from the favourable and friendly workplace environment to the employees perception of the company taking care of them (Tornikoski, 2011). Thus, it is advised to create a total reward package by including the IPRs into the compensation practices. Certain approaches, such as the cafeteria method, already provide intangible reward and thus contribute to the state of psychological contract without increasing the cost of the compensation package when applied properly. The five cultural dimensions presented by Mishra et al. (2012) also provide valuable insights into the psychological side of the workplace climate resulting from cultural conditions and prerequisites.

How can Organization design an effective compensation for international use?

Based on the reviewed literature and considering the advantages and disadvantages of the discussed approaches, we can safely assume that there is no single way of creating a successful and universal compensation strategy for international expatriates. An effective compensation package that would boost the employees affective commitment as well as foster their loyalty requires sufficient effort and attention to be conceived and maintained. Besides, the international setting further complicates the task as it introduces an additional layer of obstacles and a number of variables that are difficult to predict and can hamper the progress.

Instead of creating a single encompassing approach, a flexible framework is recommended for designing a compensation strategy that will tackle four dimensions. First, the right balance of tangible and intangible rewards should be sought. This can be done by applying the two-dimensional framework utilized by Tornikoski (2011). Once reached, the balance should be maintained by regular monitoring and correction of HR practices. As different expatriation settings include a different number of steps and variables, so the frequency and scope of screening tools must be determined individually.

The monitoring will improve the low retention rates, which are considered one of the primary concerns when it comes to successful expatriation process (Nazir et al., 2014). The disparate taxation schemes currently addressed mostly through allowances need to be addressed by creating standardized policies that would minimize the gaps and improve transitions. For instance, a global defined benefit plan would streamline the process of accumulating benefits across subsidiaries (McNeil, 2013). Finally, the cultural dimensions need to be considered in the HR practices, as utilizing them will improve both the intangible and tangible rewards and foster a more reliable psychological contract (Mishra et al., 2012).

Conclusion and Recommendations

The importance of the expatriates compensation is well understood and firmly established as an important component of the companys successful performance. Nevertheless, the HR managers continue to face several challenges when implementing it. This happens in part because all of the currently used approaches openly codify only the tangible rewards while the intangible ones, equally responsible for fostering loyalty and commitment, are implied but not directly stated. In addition, some of the approaches, such as the cafeteria method, have the potential to strengthen the psychological contract but see only limited use.

Finally, the differences in taxation and certain complex fund transfers not only increase the costs of compensation for the company but introduce stress and unhappiness for the expatriates. Therefore, three directions can be outlined for further improvement. First, the IPRs must be specifically accounted for whenever possible and preferably included in the most established and popular approaches. Second, it is advised for HR managers to seek new creative ways of implementing the variations of cafeteria method, which is currently restricted to the senior-level staff, throughout the expatriate segment. Third, the administration should seek the ways of creating a global pay scale and a global benefit program that will equalize the incentives and eliminate the majority of issues inherent in all the current methods.

References

McNeil, B. J. (2013). Executive compensation concerns related to international benefit matters. Journal of Deferred Compensation, 19(1), 1-39.

Mishra, R. K., Singh, P., & Sarkar, S. (2012). Cross cultural dimension of compensation management: global perspectives. Journal of Strategic Human Resource Management, 1(2), 63-71.

Nazir, T., Shah, S. F. H., & Zaman, K. (2014). Review of literature on expatriate compensation and its implication for offshore workforce. Iranian Journal of Management Studies, 7(2), 189-207.

Tornikoski, C. (2011). Fostering expatriate affective commitment: a total reward perspective. Cross Cultural Management: An International Journal, 18(2), 214-235.

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