HRM

Chapter Five:
Compensation

1
 Definition
• Compensation refers to wide range of financial
and non-financial rewards to employee for their
service rendered to the organization.
• It is paid in the form of wages, salaries , special
allowance and employee benefits such as paid
vacation, insurance, maternity leaves, free travel
facility , retirement benefits etc.
• Money received in the performance of work,
plus the many kinds of benefits and services that
organization provides for their employee.
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 Importance of Compensation

1. Recruitment
• The compensation packages that businesses offer to
employees play an important role in the company’s
ability to attract top talent as job candidates.
• Top-performing employees greatly impact the
competitiveness and productivity of a business.
2. Motivation
• Compensation often impacts an employee’s motivation
and job satisfaction, although it is not the only factor.
• For example, the knowledge of receiving a bonus after
achieving a certain sales quota will likely motivate a
salesperson to increase productivity.
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 Importance ….

3. Retention
• Retaining productive employees is critical to running a
successful business.
• Retaining employees saves companies money in
training costs and helps maintain an efficient and
knowledgeable workforce.
• Health insurance and retirement packages are benefits
that many employees desire from their employers.
• Companies that offer these benefits have a much
better chance of retaining workers than businesses
that fail to offer benefit packages.
• Other ways to retain employees is through regular 4
 Objectives of Compensation Planning
a) To Employees:
• Employees are paid according to requirement of
their jobs i.e highly skilled jobs are paid more
compensation than low skilled jobs.
• The chances of favoritism are minimized.
• Jobs sequence and lines of promotion are
established wherever they are applicable.
• Employee’s moral and motivation are increased
because of the sound compensation structure.

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 Objectives …..
b) To Employers:
• They can systematically plan for and control the
turnover in the organization.
• To reduces the likelihood of friction and grievance
over remunerations.
• It enhances an employee morale and motivation.
• It attracts qualified employees by ensuring and
adequate payment for all the jobs.
• In dealing with a trade union, they can explain the
basis of their wages programme because it is based
upon a systematic analysis of jobs and wages facts.
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 Factors Affecting Compensation
1. Supply and Demand of Labor:
• If more the labor is required, there will be
tendency to increase the compensation;
• In situations when anything works to decrease
the supply of labor, such as restriction by a
particular labor union, there will be a tendency to
increase the compensation.
2. Ability to Pay: Labor Unions have often
demanded an increase in compensation on the
basis that the firm is prosperous and able to pay.
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 Factors Affecting …..

3.Management’s Philosophy: Management’s desire to

maintain or improve moral, attract high caliber
employees, reduce turnover, and improve employees
standard of living also affect wages, as does the relative
importance of a given position to a firm.
4. Legislation:
• Legislation related to plays a vital role in determining
internal organization practices.
• Various acts are prescribed by government of
country for wage hours laws.
• Wage-hour laws set limits on minimum wages to be
paid and maximum hours to be worked. 8
 Modes of Compensation
1. Incentives-
• These are also known as payment by results.
• These are paid in addition to wages and salaries.
• Incentive depends upon productivity, sales, profit or
cost reduction efforts.
• Incentive scheme are of two types:
– Individual incentive schemes.
– Group incentive schemes.
2. Fringe Benefits-
• Given to employees in the form of benefits such as
provident fund, gratuity, medical care, hospitalization,
accident relief, health insurance, canteen, uniform etc. 9
 …. Compensation
3. Non- Monetary Benefits-
• They include challenging job responsibilities,
recognition of merit, growth prospects, competent
supervision, comfortable working condition, job
sharing and flexi time.
4. Wages and Salary-
• Wages: represent hourly rates of pay
• Salary: refers to monthly rate of pay irrespective of
the number of hours worked.
• They differ from employee to employee and depend
upon the nature of jobs, seniority and merit.
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 Incentives
• Incentives are monetary benefits paid to workers in lieu
of their outstanding performance.
• Incentives vary from individual to individual and from
period to period for the same individual.
• It works as motivational force to work for their
performance as incentive forms the part total
remuneration.
• Incentives when added to salary increase the earning
thus increase the standard of living.
• The advantage of incentive payment are reduced
supervision, better utilization of equipment, reduced
scrap, reduced lost time, reduced absenteeism and 11
 Kinds of Incentives
1. Individual and Organizational
• Individual incentives are the extra compensation
paid to an individual for all production over a
specified magnitude which stems from his exercise
of more than normal skill, effort or concentration
when accomplished in a predetermined way
involving standard tools, facilities and materials.
• Individual performance is measured to calculate
incentive where as organizational or group incentive
involve cooperation among employees,
management and union and purport to accomplish
broader objectives. 12
 Kinds of Incentives… Cont’d

I) Individual Incentive:
• Some important these plans of incentive wage
payments are as follows:
• Halsey Plan- Frederick A. Halsey In his famous 1891
paper "The Premium Plan of Paying for Labor," he
argued "against piecework payment and profit-
sharing, and proposing an incentive wage
• Under this plan a standard time is fixed in advance for
completing a work. Bonus is rewarded to the worker
who performs his work in less than the standard.
• The total earnings of the worker = wages for the
actual time + bonus 13
 Kinds of Incentives… Cont’d

Example:
• Time required to complete job (S) = 20 hours
• Actual Time taken (T) = 15 hours
• Hourly Rate of Pay (R) = $ 1.5
• Calculate the wage of the worker.
• Solution: T X R + (S-T ) X R
2
• 15 X 1.5 + (20-15 ) X 1.5 = 22.5 + 3.75 = $26.25

2
• In this equation $3.75 are the incentives for saving 5
hours. 14
 Kinds of Incentives… Cont’d
II) Group Incentive System is of following types
A. Co-Partnership Plan:
• In this system, the worker gets his usual wages, a share in the
profits of the company.
• When co partnership operates with profit sharing the
employees are allowed to leave their bonus with the company
as shares (bonus shares).
• This would, in turn, create a sense of belonging among
workers and stimulate them to contribute their best for the
continued prosperity to the company
B. Profit Sharing:
• Employee receives a share, fixed in advance, of the profits.
• It is paid in addition to the regular wages payable to the
worker. 15
 Kinds of Incentives… Cont’d
2. Financial and Non-financial Incentives-
i. Financial incentives:
– Include salary, premium, reward, dividend, income on
investment etc.
ii. Non-financial incentive:
– Non-financial incentives are that social and
psychological attraction which encourages people to
do the work efficiently and effectively.
– It can be delegation of responsibility, lack of fear,
worker’s participation, title or promotion, constructive
attitude, security of service, good leadership etc.
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 Kinds of Incentives… Cont’d
3. Positive and Negative Incentives-
• Positive incentives are those agreeable factors related to
work situation which prompt an individual to attain or
excel the standards or objectives set for him.
• Positive incentive may include expected promotion,
worker’s preference, competition with fellow workers
and own ‘s record etc.
• Negative incentives are those disagreeable factors in a
work situation which an individual wants to avoid and
strives to accomplish the standards required on his or her
part.
• Negative incentives include fear of lay off, discharge,
reduction of salary, disapproval by employer etc. 17
 Fringe Benefits
• Fringe benefits are any wage cost not directly
connected with the employees productive effort,
performance, service or sacrifice (D. Belcher)
• Fringe embrace a broad range of benefits and services
that employees receive as part of their total
compensation, package pay or direct compensation and
is based on critical job factors and performance
(Werther and Davis)
• “Benefits of an employee and which are not in the form
of wages, salaries and time rated payments (Cockman).
• These are indirect compensation as they are extended
condition of employment and are not related to
performance directly. 18
 Kinds of Fringe Benefits
1. Old Age and Retirement Benefits - these include
provident fund schemes, pension schemes, gratuity
and medical benefits which are provided to employee
after their retirement and during old age as a sense of
security about their old age.
2. Workman’s Compensation - these benefits are
provided to employee if they are got ignored or die
under the working conditions and the sole
responsibility is of the employer.
3. Employee Security- Regular wage and salary is given
to employee that gives a feeling of security. Other
than this compensation is also given if there is lay-off
or retrenchment in an organization. 19
 Kinds of Fringe….
4. Payment for Time Not Worked – A worker is provided
payment for the work that has been performed by him
during holidays and also for the work done during odd
shifts. Compensatory holidays for the same number in
the same month are given if the worker has not availed
weekly holidays.
5. Safety and Health –Provide safe working environment.
Safety and Health measures are also taken care of in
order to protect the employees against unhealthy
working conditions and accidents.
6. Health Benefits – Employees are also provided medical
services like hospital facility, clinical facility by the
organization. 20
 Wage and Salary Administration
• Wage and Salary Administration refers to the
establishment and implementation of sound
policies and practices of employee
compensation(D.S. Beach).
• It includes job evaluation, surveys of wage and
salaries, analysis of relevant organizational
problems, development and maintenance of wage
structure, establishing rules for administrating
wages, wage payment incentives, profit sharing,
wage changes and adjustments, supplementary
payments, control of compensation costs and
other related items.” 21
 Wage and Salary ….
• The term wage and salary administration
denotes the process of managing a company’s
compensation programme.
• The goals of compensation administration are to
design a cost-effective pay structure that will
attract, motivate and retain competent
employees (S.P. Robbins).
• Thus, wage and salary administration aims to
establish and maintain an equitable wage and
salary structure and an equitable labor cost
structure.
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 Objectives of Wage and Salary
Administration
• To establish a fair and equitable compensation
• To offer similar pay for similar work.
• To attract competent and qualified personnel.
• To retain the present employees by keeping wage levels in nine
with competitive units.
• To keep labor and administrative costs in line with the ability of
the organization to pay.
• To improve motivation and morale of employees and to improve
union management relations.
• To project a good image of the company and to comply with legal
needs relating to wages and salaries.
• To establish job sequences and lines of promotion wherever
applicable.
• To minimize chances of favoritism while assigning the wage rates.
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 Principles of Wage and Salary Administration:
1. Wage policy should be developed keeping in view the
interests of all concerned parties.
2. Wage and salary plans should be sufficiently flexible or
responsive to changes.
3. Efforts should be made to ensure that differences in pay for
jobs are based on variations in job requirements such as skill,
responsibility, efforts and mental and physical requirements.
4. Wage and salary administration plans must always be
consistent with overall organizational plans and programmes.
5. Wage and salary administration plans must be in conformity
with the social and economic objectives of the country like
attainment of equality in income distribution and controlling
inflation etc. 24
 Principles …..
6. It should be responsive to the changing local and national
conditions.
7. Wage and salary plans should expedite and simplify
administrative process.
8. Workers should be associated, as far as possible, in
formulation and implementation of wage policy.
9. An adequate database and a proper organizational set up
should be developed for compensation determination and
administration.
10. The general level of wages and salaries should be
reasonably in line with that prevailing in the labor market.
11. There should be a clearly established procedure for
hearing and adjusting wage complaints. 25
 Principles …..
12. The workers should receive a guaranteed minimum
wage to protect them against conditions beyond
their control.
13. Prompt and correct payments to the employees
should be ensured and arrears of payment should
not accumulate.
14. The wage and salary payments must fulfill a wide
variety of human needs including the need for self
actualization.
15. Wage policy and programme should be reviewed
and revised periodically in conformity with
changing needs. 26
 Factors Affecting Wage Rate Decisions
• Workers are very much concerned with the rates
of wages as their standard of living is linked to
the amount of remuneration they get.
• Managements, however, do not come forward
to pay higher wages because cost of production
goes up and profits decrease to that extent.
• A number of factors, thus, Influence the
remuneration payable to the employees. These
factors can be categorized into
(i) External Factors and
(ii) Internal Factors. 27
 Factors Affecting Wage Rate Decisions
A) External Factors
1. Demand and Supply:
• When the demand for a particular type of labor is
more and supply is less than the wages will be more.
• On the other hand, if supply of labor is more and
demand on the other hand, is less then persons will
be available at lower wage rates also.
2. Cost of Living:
• The wage rates are directly influenced by cost of
living of a place.
• The workers will accept a wage which may ensure
them a minimum standard of living. 28
 External Factors …. Cont’d
3. Trade Unions’ Bargaining Power:
• Stronger the trade union higher will be the wage rates.
• The strength of a trade union is judged by its
membership, financial position and type of leadership.
• Union’s last weapon is strike which may also be used
for getting wage increases.
• If the workers are disorganized and disunited then
employers will be successful in offering low wages.
4. Government Legislation:
• To improve the working conditions of workers,
government may pass a legislation for fixing minimum
wages of workers. 29
 External Factors …. Cont’d

5. Psychological and Social Factors:

• Management should take into consideration the
psychological needs of the employees while fixing the
wage rates so that the employees take pride in their
work.
• Sociologically and ethically, the employees want that the
wage system should be equitable, just and fair.
6. Economy:
• Economy also has its impact on wage and salary fixation.
• A depressed economy will probably increase the labor
supply. This, in turn, should lower the going wage rate.
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 External Factors …. Cont’d
7. Technological Development:
• With the rapid growth of industries, there is a shortage of
skilled resources. The technological developments have been
affecting skill levels at faster rates.
• Thus, the wage rates of skilled employees constantly change
and an organization has to keep its level up to the mark to
suit the market needs.
8. Prevailing Market Rates:
• No enterprise can ignore prevailing or comparative wage
rates.
• The wage rates paid in the industry or other concerns at the
same place will form a base for fixing wage rates.
• If a concern pays low rates then workers leave their jobs
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whenever they get a job somewhere else.
 B) Internal Factors:
1. Ability to Pay:
• If the concern is running into losses then it may not be able to pay
higher wage rate.
• A profitable concern may pay more to attract good workers.
• During the period of prosperity, workers are paid higher wages
because management wants to share the profits with labor.
2. Job Requirements:
• Basic wages depend largely on the difficulty level, and physical and
mental effort required in a particular job.
• The relative worth of a job can be estimated through job
evaluation.
• Simple, routine tasks that can be done by many people with
minimum skills receive relatively low pay.
• On the other hand, complex, challenging tasks that can be done32by
 Internal Factors …. Cont’d

3. Management Strategy:
• The overall strategy which a company pursues
should determine the remuneration to its
employees.
• Where the strategy of the organization is to achieve
rapid growth, remuneration should be higher than
what competitors pay.
• Where the strategy is to maintain and protect
current earnings, because of the declining fortunes
of the company, remuneration level needs to be
average or even below average.
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 Internal Factors …. Cont’d
4. Employee:
i. Performance or productivity is always rewarded with a pay
increase.
ii. Seniority: Unions view seniority as the most objective
criteria for pay increases whereas management prefers
performance to effect pay increases.
iii. Experience: Makes an employee gain valuable insights and is
generally rewarded.
iv. Potential: Organizations do pay some employees based on
their potential. Young managers are paid more because of
their potential to perform even if they are short of
experience.
v. Luck: Some people are rewarded because of their sheer luck.
They have the luck to be at the right place at the right time.
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 Wage and Salary Determination Process
i) Job Analysis:
• A job analysis describes the duties, responsibilities,
working conditions and interrelationships between the job
as it is and the other jobs with which it is associated.
• Job descriptions are crucial in designing pay systems, for
they help to identify important job characteristics.
• They also help determine, define and weigh compensable
factors.
• After determining the job specifications, the actual process
of grading, rating or evaluating the job occurs.
• A job is rated in order to determine its value in relation to
all other jobs in the organization which are subject to
evaluation.
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• The next step is that of providing the job with a price.
 …… Determination Process

ii) Conduct the Salary Survey:

Employers use salary surveys in three ways:
A. Survey data are used to price bench mark jobs that anchor
the employer’s pay scale and around which the other jobs
are slotted, based on their relative worth to the firm.
B. Some Jobs of an employer’s position are usually priced
directly in the market place (rather than relative to the
firm’s benchmark jobs), based on a formal or informal
survey of what competitive firms are paying for
comparable jobs.
C. Surveys also collect data on benefits like insurance, sick
leave and vacations to provide a basis for decisions
regarding employee benefits. 36
 …… Determination Process
iii) Group Similar Jobs into Pay Grades:
• After the results of job analysis and salary surveys
have been received, the committee can turn to the
task of assigning pay rates to each job, but it will
usually want to first group jobs into pay grades.
• A pay grade is comprised of jobs of approximately
equal difficulty or importance as determined by job
evaluation.
• Pay grading is essential for pay purposes because
instead of having to deal with hundreds of pay
rates, the committee might only have to focus on
say 10 or 12. 37
 …… Determination Process
iv) Price Each Pay Grade:
• The next step is to assign pay rates to pay grades.
• Assigning pay rates to each pay grade is usually
accomplished with a wage curve.
• The wage curve depicts graphically the pay rates
currently being paid for jobs in each pay grade,
relative to the points or rankings assigned to each
job or grade by the job evaluation.

38
 …… Determination Process
v) Fine-Tune Pay Rates:
Fine tuning involves correcting out of line rates and developing
rate ranges:
a) Developing Rate Ranges:
• Most employers do-not pay just one rate for all jobs in a
particular pay grade. Instead, they develop rate ranges for each
grade so that there might be different levels and corresponding
pay rates within each pay grade. The rate range is usually built
around the wage line or curve.
• One alternative is to arbitrarily decide on a maximum and
minimum rate for each grade. As an alternative, some
employers allow the rate range for each grade to become wider
for the higher pay ranges reflecting the greater demands and
performance variability inherent in these more complex jobs.39
 …… Determination Process
b) Correcting out of Line Rates:
• The average current pay for a job may be too high or too low,
relative to other jobs in the firm.
• If a rate falls well below the line, a pay rise for that job may be
required. If the rate falls well above the wage line, pay cuts or a pay
freeze may be required.
• There are several ways to cope with the over paid employees:
i. To freeze the rate paid to employees in this grade unless general
salary increases bring the other jobs into line with it.
ii. To transfer or promote some or all of the employees involved to
jobs for which they can legitimately be paid their current pay rates.
iii. To freeze the rate for some time, during which time the overpaid
employees should be transferred or promoted. If it cannot be
done, then the rate at which these employees are paid is cut to
the maximum in the pay range for their pay grade. 40
 …… Determination Process
vi) Wage Administration Rules:
• The development of rules of wage administration has
to be done in the next step.
• It is considered advisable in the interest of die
concern and the employees that the information
about average salaries and ranges in the salaries of
group should be made known to the employees
concerned; for secrecy in this matter may create
dissatisfaction and it may also vitiate the potential
motivating effects of disclosure.
• Finally, the employee is appraised and the wage is
fixed for the grade he is found fit.
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 Executive compensation
• Executive compensation: Refers to remuneration packages
specifically designed for business leaders, senior
management and executive-level employees of a company.
• Executive compensation includes benefits such as salaries,
perks, incentives, insurances etc.
• The types of employees that are typically paid with executive
compensation packages include corporate presidents, chief
executive officers, chief financial officers, vice presidents,
managing directors and other senior executives
• CEO pay is much more than the average
employee compensation.
• Although most people think CEOs should be paid more than
the average employee, the pay discrepancy causes long-term
dissatisfaction in the workforce. 42
 Executive compensation …. Cont’d
• Executives who are improperly compensated
may not have the incentive to perform in the
best interest of shareholders, which can be costly
for those shareholders.
• While new laws and regulations have made
executive compensation much clearer in
company filings, many investors remain clueless
as to how to find and read these critical reports.
• The followings are different types of executive
compensation and how investors can find and
evaluate compensation information. 43
 Types of Executive Compensation
1. Cash compensation – This is the sum of all standard
cash compensation the executive receives for the year.
2. Option grants – A right to acquire a set number of
shares of stock of a company at a set price to the
executive.
• Stock options, if used the right way, are a terrific way to
inspire management to maximize shareholder value.
• Example, management is awarded a significant options grant
that is barely out of the money, meaning if the stock price
goes up a little, management will be able to exercise options,
convert them to common stock and sell the shares to reap a
quick windfall.
44
 ……… Executive Compensation
3. Deferred compensation
• This compensation is deferred until a later date,
typically for tax purposes.
• However, changes in regulations have lessened the
popularity of this type of compensation.
4. Long-term incentive plans (LTIPs)
• A company policy that rewards executives for
reaching specific goals that lead to increased
shareholder value.
• Long-term incentive plans encompass all
compensation tied to performance for tax purposes.
45
 ……… Executive Compensation
5. Retirement packages
• It is customary for some executives to receive health benefits
upon retirement for years of service, or other reasonable perks.
• These are important to watch because they can contain so-
called golden parachutes for corrupt executives or be payable
regardless of whether the company meets its financial
objectives or is even profitable.
6. Executive Perks
• Includes the use of a private automobile, travel
reimbursements, and other rewards.
• Perks paid out to executives at small companies should be
subject to even greater scrutiny because this type of greed is
more likely to bankrupt smaller companies or contribute to
annual deficits. 46
 Evaluating Executive Compensation
A) Pay vs. Performance
• One of the most popular ways to evaluate
executive compensation is by comparing pay
and performance.
• Comparing pay to stock performance can help you
determine whether executives are overpaid.
• The specific metric used most often is comparing
the change year over year in executive pay
increases to the change year in stock price.
• If the change in the stock price outpaces the
change in pay, the executive is not overpaid.
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 Evaluating Executive Compensation …. Cont’d
B) Peer Comparison
• While market leaders typically
have CEOs who are paid slightly more than their
industries, the majority of executives should be
paid on par with their peers.
C) Executive Compensation Laws
• There have been many new laws passed to help
satisfy organization concerns over executive
compensation.
• Laws have been more direct in curbing
practices the companies themselves use. 48
Thank You !

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