CHAPTER 1

FOUNDATION OF COMPENSATION ADMINISTRATION

Compensation is defined as the means of giving a monetary value equivalent to any work
performed by an employee. It is also referred to as all financial rewards and nonfinancial
rewards which an employee may receive out of a work rendered for the employer (Milkovich,
Newman, & Gerhart, 2013).

BASIC TYPE OF COMPENSATION

1. Base Pay. It is the basic pay given to the employee for the actual work rendered usually
in the form of salary or wage. It is the pay that was negotiated and agreed upon by the
employee and the employer during the hiring process.
2. Variable Pay. It is the pay linked to actual accomplishments in performance such as
bonuses or incentives based on a target sales quota or target productivity.
3. Benefits. These are indirect rewards which may either be government-mandated or
voluntarily given by the employer. Examples are: health insurance and vacation and sick
leaves.

OBJECTIVES OF COMPENSATION
➢ To retain high performance employees and reduce employed turnover.
➢ To achieve high productivity and efficiency by providing fair compensation among
employees commensurate to their position, and
➢ To satisfy pay requirements in accordance with the law.

CLASSIFICATION OF COMPENSATION
➢ Direct Compensation refers to the actual monetary value that entitles an employee. It
can be in the form of a salary or wage. It can also be in the form of variable pay such
as bonuses, incentives, commissions, and other performance-based pay. Money is
usually attached to direct compensation.
➢ Indirect Compensation refers to nonmonetary aspects of compensation, such as
benefits packages that include hospitalization and life insurance plans, sick and
vacation leaves, car plans, and educational grants among others. It is usually referred
to as the "add-on" or the extra component of base pay (Armstrong, 2015).

POLICIES AFFECTING COMPENSATION

Internal Alignment. One of the challenges of managers is to make the employees happy with
their pay. They should see to it that there is internal alignment for employees having related or
similar tasks and those who have unrelated or dissimilar jobs. If managers can align pay with
the contributions of employees in achieving organizational objectives, then there is lesser
discontent in the organization.
External Competitiveness. Another policy is ensuring competitiveness by aligning pay with
competitors. This can attract more applicants because the salaries are competitive, so to speak.
Some companies pay more than their competitors give, especially basic pay to retain employees
and to ensure their salaries. are not far behind the company's competitors. This prevents them
from leaving and transferring to a competitor.
Employee Contribution. Another policy to look at is the employee contribution. A major dilemma
among managers is to consider employee contribution to performance as a factor of pay. Should
all sales representatives be paid a minimum salary while incentives are based on the
achievement of individual sales targets? Or should their basic pay be based on their
performance while incentives are team-based?
Management of the Pay System. Managers in the organization should be capable of putting a
system to the giving of compensation. Employees should be worthy of the pay that they receive.
There should be fairness in providing compensation for everyone in the organization. No one
should be discriminated against, and each employee should be paid justly. Managers should also
consider the timeliness of pay. Compensation policies include the payment schedule and how
payment is distributed.

COMPONENTS OF A COMPENSATION SYSTEM

Job Analysis. It is defined as the process of determining all the information specific to a
particular job. The different tasks or activities, such as drafting, drawing, writing, teaching, and
encoding, are obtained
Job Description. It is referred to as the written summary of all the duties and responsibilities of
a particular job position. It also includes the job specification which describes the educational
background, experience, skills, and personal traits that are needed to perform a particular job.
As previously mentioned, job analysis is done to write job descriptions for all jobs in the
organization.
Job Evaluation. While job analysis provides all the information for each job, job evaluation is
the process of determining the worth of a job (Dessler, 2015). The worth or value of the job in the
organization forms a big part in determining pay: rates, specifically basic pay. It also organizes
jobs into a hierarchy as pay levels are developed.
Pay Structures. Many organizations standardize their pay and use grades or levels. Pay structures
help in determining entry pay and incremental increases during performance evaluation or
promotion. They minimize complaints on the corresponding number of increases because they
are structured and systematically arranged per grade or level.
Salary Surveys. Some organizations participate in salary surveys and purchase market data on
prevailing rates for different positions in the industry where they belong. These help in
determining appropriate rates and at the same time remaining competitive among competitors.
Policies and Regulations. Each organization has its policies in administering and implementing
its payment system. These depend on many factors including the organization's capacity to
provide compensation, and the standards set by law. This also indicates the kind of support that
the top management has given in the implementation of compensation packages.

THEORIES ON WAGES
1. Subsistence Theory
This theory is the most popular economic theory on wages. For this reason, so
many viewpoints and articles were written on this theory, and this became the basis for
the minimum wage concept. It is also based on the theory of population by Thomas
Malthus. According to the subsistence theory, an increase in wages above the minimum
or subsistence level will only lead to an increase in population at a faster rate.
The tendency of wages to remain fixed at a subsistence or minimum level that led
to its being called the Iron Law of Wages or Brazen Law as coined by Ferdinand Lassalle, a
German economist. According to this theory, wages cannot fall below the minimum
because workers wil not be able to work. Since there are also few slots available for
employment, workers compete. This competition will drive the wages down to the
minimum level.
David Ricardo, a British economist, used the terms natural price and market price
of labor to explain the Iron. Law of Wages. A natural price of labor is a price that is needed
for a laborer to sustain himself/herself. Whereas the market price of labor is the price
paid for the labor as provided by the worker. This market price is never constant.

2. Just Price Theory

This theory upholds the equity theory of J. Stacey Adams. This theory emphasizes that
employees would like to maintain equity between inputs (their contribution to the job) and
outputs (the outcomes that they receive out of the perceived efforts they have given to the
organization) (Miner, 2015).
In this theory, wages are provided based on the status or position of each
employee. Employees with high positions have higher wages. The hierarchy of positions
also follows a hierarchy of wages.
3. Wage Fund Theory
Adam Smith developed this theory to mean that workers are paid based on a
fund that is already there in the first place. This fund is also called the wage fund.
Employees or workers will be paid equally by dividing the wage fund over the number of
workers. The lower the number of workers, the higher the wage.
Classical economist John Stuart Mill supported Adam Smith's theory on wage
fund. According to Mill, this theory considers the available wage fund and the number of
workers to determine the employees' wage level. The wage fund may come from
accumulated capital or wealth that will be used as payment of wages.

4. Residual Claimant Theory

William Stanley Jevons was the first to state it in 1862, but Francis Walker was
 able to make a more profound analysis after 20 years. According to this theory, wages are
residual claims after rent, interest, and profits are deducted from the total product. It
suggests that residual claims will only increase if productivity increases, given that there
is no additional investment or capital infused for workers to get more residuals.

5. Standard of Living Theory

This theory is a better version of subsistence theory in that, wage is determined

by the standard of living of the workers. A standard of living is defined as the level or
quality of life that a particular worker enjoys in a particular location or area. It includes
the necessities of life, education, and recreation which he/she has become accustomed
with.

6. Bargaining Theory
John Davidson developed this theory to highlight the bargaining power of workers
in negotiating their wages. This is especially true for labor unions that negotiate their
wages on the bargaining table. Wages are high if the workers are stronger than the
employer. If the latter is stronger than the workers, the wages tend to be low.

DIFFERENCE BETWEEN WAGE AND SALARY

COMPENSATION CONCEPT

Compensation administration is borne out of several disciplines. Because of the issues that need
to be addressed, it combines the different concepts to be able to have a deeper understanding
of compensation as a key function of human resource management.

Economic Concept. Labor services are one of the factors of production. Just like raw material
resources, labor services may also be scarce. Compensation is the price given for labor services.
Normally, a firm strives to get the most number of laborers at a reasonable price. On the part
of the workers, they also try their best to get paid at the highest price.
Psychological Concept. Compensation is a form of motivation. Employees who believe that they
are well compensated may be highly motivated and, thus, may be highly productive. Although
there are other reasons why employees may be loyal to the organizations they work for,
compensation is one of the key factors why employees will opt to stay.
Sociological Concept. Compensation is a form of status symbol. Positions have a corresponding
compensation package depending on the level in the hierarchy. Top executives like the chief
executive officer, chief operating officer, president, and others enjoy high compensation
packages. Since they occupy key positions, their compensation packages become a status
symbol.
Political Concept. In some organizations, compensation is negotiated at the bargaining table
using power and influence. The union may be more powerful to influence management to give
in to its demands. Meanwhile, reputable organizations that provide high compensation
packages become leaders in their respective industries and, thus, become the benchmark for
other companies to follow.
Equity Concept. Fairness is always attached to compensation. Employees want to perceive their
pay as commensurate with their contributions in the organization. Usually, employees compare
their compensation to others doing the same job.
Communications Concept. Because of the easy access to technology, the Internet can provide
salary surveys of different positions anytime. They are readily available so applicants can always
ask for whatever salary rates they have seen or read from the Internet. Because of this
information, organizations are sometimes wary on how they are going to negotiate the rates that
they can afford to provide against what the surveys have shown to the applicants. On the other
hand, what is good about these salary surveys is that majority of these are "average" rates.

LABOR MARKET THEORIES

In recent years, labor economists have developed theories that explain the labor market. These
theories also explain the role of compensation as vital in labor services.
Labor Markets. The labor market is very dynamic. The market provides comprehensive
salary rates for most jobs available in the market. The salary surveys are well researched and
can be accessed by both prospective employees and employers. In this manner, applicants are
provided with "average" rates and compare them with what the companies offer. They also
have a way of how they can negotiate with their prospective employers. Meanwhile,
organizations can also use salary surveys to come up with competitive salaries for their
employees.
Labor Supply. The Philippine Statistics Authority released its employment rate of 94.7 together
with the Labor Force Survey (LFS) for January 2018 (Philippine Statistics Authority (PSA), 2018).
The labor force is the quantity of the labor supply and the labor force participation rate (LFPR)
is taken from the population 15 years old and over. In October 2018, 43.5 million were either
employed or unemployed. The LFPR was 60.6% (PSA, 2019). Based on the survey, regions with
the lowest employment rates are the following: National Capital Region, locos Region, and
CALABARZON.
The Labor Market Worldwide. The working age for the global labor market consists of men and
women ages 15 years and above. This comprises about 5.7 billion with 3.3 billion or 58.4 percent
are employed and 172 million are unemployed. The 38.6 percent are currently not in the labor
force but are currently pursuing further studies, in retirement, or in unpaid care work. Unpaid
care work is simply household chores done without salary, such as cleaning, cooking, and the
like.
Human Capital Theory. This explains the quality of the labor force. Normally, employers seek
applicants who are highly skilled and well trained. They value extensive job experiences as a key
factor in hiring. This is the reason why compensation is also based on the qualifications needed
on the job.

Labor Demand. The demand for workers is dictated by employers. In a news report, the
business process outsourcing (BPO) industry still generates the highest number of jobs in the
Philippines. These BPO jobs include finance, accounting, information technology, and customer
service. According to Jobstreet.com, retail and manufacturing jobs were also in demand in 2018.