How should we compensate an employee on a foreign assignment?

The most common approaches taken by organizations are the balance sheet (or buildup system), negotiation, localization, lump sum and cafeteria plans. Each plan is best suited to certain situations, and each plan has its advantages and disadvantages.

Balance sheet

This approach is most common. The main emphasis of the balance sheet is to pay an expatriate comparably to incumbents in same or similar positions in the home country. Thus, the expatriate neither gains nor loses from a financial perspective.

A home-country salary (base salary plus incentives) is determined for the expatriate. Frequently, this salary is determined in the same manner as that for a domestic position, such as by a job evaluation or a competency-based plan, market surveys, merit, and incentives. This salary is then broken into four categories. The categories are taxes, housing, goods and services, and reserve (e.g., savings and discretionary payments).

The employee is required to use his or her salary to pay the typical amount toward each of these four categories. The typical amount reflects consumption patterns in the home country as determined by surveys from various consulting firms. The employer retains any amount under the typical amount and pays for any amount over the typical amount for each of the categories. Organizations often provide a relocation incentive in addition to the salary because certain assignments and locations require more than comparable pay to motivate an employee to take the foreign assignment.

The balance sheet approach is most appropriate for experienced mid- to senior-level expatriates. Its advantages include keeping the expatriate whole from a compensation perspective with respect to incumbents in the same or similar positions in their home country. In addition, this approach allows for ease of movement between foreign assignments and back to the home country (repatriation). Conversely, the balance sheet approach is complex to administer and intrudes into the expatriate’s finances.

Negotiation

The advantage of the negotiation approach is that it is conceptually simple; the employer and each individual expatriate simply find a mutually agreeable package. However, this approach tends to be relatively costly, and it creates comparability problems when an increasing number of expatriates are compensated with the method. Negotiation is most often used for special situations or in organizations with few expatriates.

Localization

This approach involves basing the expatriate’s salary on the local (host country’s) salaries. It is easy to see that the same position in different countries may have quite different salaries. This approach contrasts with the balance sheet approach. The localization approach also provides for cost-of-living allowances, which can be applied to taxes, housing and dependents and which is similar to the balance sheet method.

Some advantages of the localization approach include ease of administration and equity with local nationals. Some disadvantages include the usual need for negotiated supplements and pay based on host country economics versus performance and job responsibilities.

Lump sum

This approach uses the home country’s system for determining base salary. In addition to the salary, the expatriate is offered a lump sum of money to apply to items that he or she values versus a specific amount for taxes, housing and so forth. This approach is advantageous because it does not intrude into the expatriate’s finances, and the employer does not pay for things the expatriate does not want. A disadvantage to the lump sum approach is the calculation of the lump sum. It may involve a complex and time-consuming analysis. This approach is most often used for one- to three-year assignments.

Cafeteria

Senior-level expatriates and those with high total incomes relative to base salary are often compensated by the cafeteria method. This approach can be more cost-effective than other methods. The cafeteria method is similar to the lump sum plan, but instead of being provided a single sum of money, the expatriate is offered a selection of options to choose from. Options might include a company car or employer-paid tuition for the expatriate’s children. There is, however, a limit to choices and amounts.