Compensation

Compensation Concept
Compensation refers to a wide range of financial and non-financial rewards to employees for their services rendered to the organization.

It is paid in the form of wages, salaries, and employee benefits such as paid vacations, insurance, maternity leave etc.
Basic compensation involves monetary benefits to employees in the form of wages and salaries.

 Compensation of employees for their services is an important responsibility of HR Deptt.

Every organization must offer good wages and fringe benefits to attract and retain talented employees. Compensation of the workers vary depending upon the nature of the job, skills required, risk involved, nature of working conditions, paying capacity of employer, bargaining power of trade unions etc.

Compensation is viewed as a system of rewards to motivate employees, so that organization achieve its intended objectives.

EMPLOYEES PERSPECTIVE

What compensation do you seek?

Direct
Money

Indirect
Benefits

EMPLOYERS PERSPECTIVE

What do you compensate? Job: Individual Characteristics:

Responsibility
Critical function Job content

Ability
Training Education

COMPENSATION MANAGEMENT
Compensation is what employees receive in exchange for their contribution to the organisation. Total compensation =
Direct + Indirect Compensation

Base Pay

Incentives

Benefits

Characteristics-Compensation System
It enables an organization to attract and retain qualified, competent worker. It motivates employee performance. Its cost structure reflects the organization ability to pay It is sum-total of different components (financial and non-financial) It complies with Government regulations.

Objectives of Compensation System

Acquisition and retention of qualified personnel Legal compliance with all appropriate laws and regulations Ensuring Growth in a Cost effective way for the organization Internal, external, and individual equity for employees Performance enhancement for the organization Higher efficiency, morale & motivation Reduction in turnover, grievance and frictions Improving quality, performance Rewarding desired behavior

Principles of Compensation System

Compliance- to govt. regulations Equity- Internal and external relativity. Fairness Balance- Pay, benefit-provide a total package. Cost Effectiveness -Pay should not be too excessive. Security- Employee feel secure , satisfy basic needs. Incentivizing/ motivation- Pay should motivate rather than control. Acceptable to Employee-Feel reasonable. Understandability Administrative efficiency

Factors Influencing-Compensation System

Organization ability to pay. Supply and demand of labor. Prevailing market rate. Cost of living. Living wage Trade union bargaining power. Job-requirements. Managerial attitude.

Compensation Dimensions
Pay for Work and Performance: base pay, premiums and differentials short-term bonuses, merit pay and certain allowances Pay for Time not worked: pay for holidays, longer paid vacations, and paid time-off for a wide variety of personal reasons Disability Income Continuation: social security, workers compensation, sick leave, and short-term and long-term disability plans Deferred Income: social security, employer provided pension plan, savings plans, annuities and supplemental income plan. Tax benefits, Stock purchase options, and grant plans are commonly used.
Contd..

Compensation Dimensions
Family Income Continuation: life insurance plans, pension plans, social security, workers compensation Health, Accident, and Liability Protections: insurance plans, payment for medical related services Income Equivalent Payments: perquisite, perks, tax benefits, use of company car, payment for expenses to professional meetings, subsidized food services, and child care services.

SCOPE/COMPONENTS OF COMPENSATION MANAGEMENT

I. Job Evaluation II. Wages/salary surveys III. Development and maintenance of wage structure IV. Establishment of rules for administering wages V. Wage incentives and profit sharing VI. Wage changes and adjustments VII. Supplementary payments VIII. Control of compensation costs IX. Other related items like promotions, relations with supervisors

First mistake is the difficulty of organizations in distinguishing between a bonus and an incentive. A bonus is a surprise. An incentive is linked with some measurable outcomes. The second mistake is the tendency of the organizations to solve compensation claims on ad-hoc basis. Often organizations tend to comprise with the talents doling out liberal compensation, creating imbalance in the internal pay equity. The third mistake in compensation design is structuring of equity participation plan. Whether it should be an expensing option, sweat option, phantom stock, etc. often confuses the organization and ultimately drains organizational resources.

Mistakes in compensation designing

COMPONENTS OF COMPENSATION
According to Thomas J.Bergmann (1988) compensation consists of four distinct components and they are:
wage or salary employee benefits non-recurring financial rewards non- financial rewards

COMPONENTS OF COMPENSATION
Components of compensation are:
Wages: aggregate earnings of an employee for a given period of time such as a day, a week or a month. It includes basic wage and other allowances. Salary: compensation paid to an employee for service rendered. Employee Benefits: Indirect and recurring monetary rewards that an employee receives from employment,eg.company contribution to retirement & insurance plans. These benefits are also called fringe benefits. Non-recurring Financial Rewards: monetary benefits an employee earns through employment but that do not occur automatically (They are earned only on occurrence of established measure of performance) eg.special commissions ,profit sharing etc. Non-pecuniary Rewards: those that can not be expressed in financial or economic terms.eg-employee participation, challenging job etc.

COMPENSATION STRUCTURE

FIXED (A)
-BASIC

VARIABLE (B)

BENEFITS (C)

RETIRALS (D)
-CAR/HOUSE
-PF -GRATUITY -PENSION -SUPER ANNUATION

DEDUCTIO NS (E)
PROFESSIONA L TAX
-PPF

-JOINING BONUS PERFORMANCE -LOAN -HRA BONUS -LEAVE ENCASHMENT -DA -ASSURED -Ex-GRATIA BONUS -CAR/HOUSE -EDU. ALLOWANCE -MOBILE/TEL -CAR/HOUSE -PERTOL/DIESEL -CAR/HOUSE -FOOD COUPONS -INCENTIVES -LTA -MEDICAL -ESIC -ESOP -PROFIT SHARING

ANNUAL GROSS:[(A+B+ D+ Medical +LTA + Mob/Tel/Petrol/Diesel)-E] Net: [(A+B)-E] CTC: Cost to Company(A+B+C+D)

TYPES OF COMPENSATION

Two Types
Direct compensation
The employer exchanges monetary rewards for work done.

Indirect compensation
Employer-provided benefitslike health insurance that are provide employees for being a member of the organization.

DIRECT COMPENSATION
Basic Salary House Rent Allowance Conveyance Leave Travel Allowance Medical Reimbursement Bonus Special Allowance

INDIRECT COMPENSATION
Leave Policy

Overtime Policy
Hospitalization Insurance Travelling Leave Benefits Retirement Benefits

Holiday Homes
Flexible Timings

COMPENSATION SYSTEM

COMPONENTS OF THE COMPENSATION SYSTEM

BASE Vs SUPPLEMENTARY COMPENSATION

BASE COMPENSATION
1. 2. 3. 4. It denotes payments to workers in the form of wages and salaries Wages and salaries are paid in cash Wages and salaries are paid to compensate employees for their services Wages and salaries are determined by JE, demand and supply of labour, organisations capacity to pay, productivity, govt regulations etc

SUPPLEMENTARY COMPENSATION
1. It denotes fringe benefits to workers over and above their regular wages and salaries 2. Fringe benefits are offered in the form of employee services and benefits 3. Fringe or non-wage payments are made to increase the efficiency of employees and to retain them 4. Supplementary compensation are determined by the history of the organisation, philosophy of management, organisations capacity to spend on employees benefit, need to retain talented employees and desire to enhance public image etc

TOTAL REWARDS PROPOSITION

COMPENSATION RELATED a. Merit based salary increase b. Competitive market positioning c. Joining bonus d. Special technical premiums e. Long-term incentives-Cash/Equity f. Greater focus on Benefits management g. Bi-annual salary reviews NON-COMPENSATION RELATED a. T & D opportunities b. Providing special projects c. Employee engagement activities d. Other recognitions awards, one to one meeting with top management e. Work-Life balance

WAGES
Wage may be defined as a aggregate earning of an employee for a given period of time such as a day, a week or a month for the service rendered by him to employer.
It is the payment made to the worker for placing skill and energy at the disposal of an employer.

WAGES
There are two other terms Compensation or Earnings are used in place of wage. The term Compensation includes everything which an employee receives in return for his work.

The term Earnings relate to remuneration in cash or in time paid to the employee

Minimum Wage
In relevance to minimum wages act of 1948,minimum wage is that wage which must be paid to the employee weather the company earn any profit or not. The rates are fixed according to the minimum wages act of 1948.Example is as under(Oct-10-March 2011):Sr. No. Category of Basic workers Minimum Scheduled Employment Wages Skilled 149 Semi-Skilled 139 Blanket Manufacturing Un-Skilled 132 Skilled 149 Semi-Skilled 139 Bone Mills Un-Skilled 132 Total Minimum Wages V.D.A. 19.03 19.03 19.03 19.03 19.03 19.03 168.03 158.03 151.03 168.03 158.03 151.03

Living Wage
A living wage is one which should enable the earner to provide himself and his family not only the essential food, clothing & shelter but also a major component including education for the children, protection against ill health, insurance etc. In other words living wage provides the standard of living and ensures good health of workers and his/her family members.

FAIR WAGE
It is the wage which is above the minimum wage but below the living wage. The lower limit of fair wage is obviously the minimum wage and upper limit is set by the capacity of the industry to pay.

IMPORTANT TERMINOLOGY
Task: It refers to a distinct work activity with an identifiable beginning and end .
for e.g.. Sorting a bag of mail into appropriate boxes.

Job: Job is an assignment of work calling for a set of duties,responsibilities,and conditions that are different from those of other work assignment .
For e.g. two salesmen who are performing similar duties and who require similar training, experience and personal characteristics would be said to hold the same kind of job though they may be working in widely separated parts of the store.

 Position: A position is a set of duties and tasks assigned to an individual.

There are as many positions as the number of persons in an organization.
Thus, when several persons are engaged in similar work, each one is to have the same job, but all have different positions.

The term position is represented by a position-holder.

 Occupation/profession: This term is used in wider sense. An occupation/profession refers to group of jobs that are similar as to kind of work or that possess common characteristics. E.g. Engineering / Medical Job family: It implies jobs of a similar nature,e.g. clerical jobs.

PROCESS OF WAGE DETERMINATION

6

5 FINE - TUNE RATES OF PAY

WAGE & SALARY ADMINISTRATION RULES 4 3 2 1 WAGE OR SALARY SURVEY GROUP SIMILAR JOBS INTO SIMILAR GRADES

PRICE EACH GRADE

JOB ANALYSIS

STEPS INVOLVED IN DETERMINATION OF WAGE

JOB ANALYSIS WAGE SURVEYS & ANALYSIS OF ORGANIZATIONA L PROBLEMS WAGE LEGISLATION

JOB DESCRIPTION & SPECIFICATION

JOB EVALUATION

WAGE STRUCTURE

RULES OF ADMINISTRATIO N WAGES PERFORMANCE STANDARDS

EMPLOYEE APPRAISAL

WAGE PAYMENTS

Theory of Wages

Economic Theory of Wages

There are two key theories that explain why salaries are the way they are in a particular field. These two theories are:
1. Traditional theory of wage determination 2. Theory of negotiated wages

1. Traditional theory of wage determination

In this theory the law of supply and demands dictates salary. Example: electricians / plumbers whose specialized skill the people need are in great demand and thus have a high wage

2. Theory of Negotiable Wages

Those employees who work in unions where union negotiates salary on behalf of all workers fit in this theory. Different methods of wage payment are prevalent in different industries and in various countries. There may be payment by time or payment by results/output. Wages are fixed mainly as a result of individual bargaining or collectively bargaining or by state regulations.
Contd

 How wages are determined has been the subject of several theories of wages. The main element of these theories may be summed up as follows:
1. 2. 3. 4. 5. 6. Subsistence Theory Wage fund theory The surplus value theory of wages Residual Claimant theory Marginal Productivity Theory The Bargaining theory of wages

Contd

(1) Subsistence Theory

This theory is also known as Iron Law of Wages given by David Ricardo(1772-1823). This theory states that The laborers are paid to enable them to subsist (survive) and perpetuate (compete/continue) the race without increase or diminution(reduction). The theory was based on the assumption that if the workers were paid more that subsistence wage ,their numbers would increase; and this would bring down the wages.
Contd

Subsistence Theory
On the other hand, If the wage fall below the subsistence level ,the number of workers would decrease as many of would die of hunger, malnutrition, disease ,cold etc.

In economics, this theory of wages states that wages in long run will tend to be the minimum value needed to keep the workers alive. The justification of this theory is :
Wage are higher More workers are produced Wage are lower Some workers will die Thus creating an equilibrium in both the case

Criticisms: Based on population. No consideration for the demand for labor. No emphasis on efficiency of workers. No explanation of wage differentials.
Contd

(2)Wage Fund Theory

Adam Smith (1723-1790). According to this theory the wages are paid out of a predetermined fund of wealth which lay surplus with wealthy persons as a result of their savings. This fund can be utilized for employing laborers for work. If the fund is LARGE wages are High If the fund is SMALL wages will be reduced The size of the fund determines the amount of payment of wages. Criticisms: No emphasis on efficiency and productivity of labor. It is Unclear from where the fund will come. It does not explain the difference in wages at different levels.
Contd

(3)The Surplus Value theory of Wages

This theory was developed by Karl Marx According to this theory the labor was an article of Commerce, which could be purchased on the payment of Subsistence Price. The price of any product was determined by the labour time. The laborer was not paid in proportion to the time spend on work, but much less , and the surplus went over , to be utilized for paying other expenses.

The rate of surplus value , which is the ratio of surplus labour to necessary labour, is also referred as rate of exploitation under the capitalist for increase of production.
Criticisms: Labour was treated as a commodity or as article. Wages are not paid in proportion to the time spent. No emphasis was given on efficiency and productivity of workers.
Contd

(4) Residual Claimant Theory

This theory was developed by Francis A. Walker(1840-1897). According to this theory There are four factor of production viz. land, labour, capital, and entrepreneurship. Wages represents the amount of value created in the production, which remains after payment has been made for all these factors of production. Wages are nothing but the residue of total revenues after deducting all other legitimate expenses such as rent, taxes, interest and profits. In other words, labour is the residual (leftover) claimant(applicant) Criticisms:

Wages not dependant on the profits or the capacity of an organization. Workers efficiency and productivity were not taken into consideration .
Contd

(5) Marginal Productivity Theory

This theory was developed by Phillips Henry Wicksteed (England) and John Bates Clark(USA). According to this theory wages are based upon an entrepreneurs estimate of the value that will probably be produced by the last or marginal worker. In other word it is assumed that wages depend upon demand and supply of labour.
Criticism: It is wrong to assume that more labour could be used without increasing the supply of production facilities. Employer offer wages less than the marginal productivity of labour.
Contd

(6) The Bargaining theory of wages

John Davidson formulated this theory. Under this theory wages are determined by the relative bargaining powers of the workers or trade unions and of employers. If the workers are stronger in bargaining process the wage tend to be high ,in case employer plays a stronger role then wage tends to be lower. Basic wages, fringe benefits, job differentials etc tend to be determined by the relative strength of the organization and the trade union.
Criticisms: If trade union is not strong enough to bargain with the management, the workers would be paid less wages. Length of service of workers, efficiency, performance does not taken into consideration.

Reward Management

Definition
Process through which there is formulation and implementation of strategies and policies to reward people fairly, adequately, equitably, timely and consistently in order to achieve organizational goals Deals with the design, implementation, and maintenance of the reward system (process and practices) and aim to meet the needs of employee and the organization both

Objective
To reward timely, sufficiently, equitably To ensure consistency in reward mechanism To reward people for the value they create To motivate people and get their commitment To develop a desired performance culture To bring harmony in peoples and organizations objective To achieve organizational goals To create reward system and strike a balance between financial and non-financial rewards To introduce transparency To reward objectively and remove subjectivity

Components of RM
Reward strategy Provides a sense of purpose and direction and framework for reward system (policies, practices and processes) Is according to the organizational goals and is focused in developing the maximum value for the organization regarding rewards) Reward system: consist of interrelated policies, processes and practices Policies: market comparability, equality, approach to total reward (tangible & intangible), transparency, policies to performance, competence and skills, role of subjectivity Processes: efficiency in evaluating the jobs and assessing the individual performance Practices: combination of monetary and non-monetary rewards Procedures: operated to ensure the system in place and operates efficiently, effectively and flexibly Total reward: combination of financial and non-financial rewards focusing on the maximizing the combined effort in optimum satisfaction of the various needs of the employee to enhance motivation, commitment, performance and satisfaction. Direct
Basic pay, grade structure Contingent or performance pay: dependent on individual performance

Indirect
Benefits and allowances Job enrichment and enlargement Non financial rewards: Training, career development, recognition

Process of RM
Environment Business Strategy HR strategy Environment

Environment

Reward Strategy

Reward Policy

Reward Practice

Reward Procedures

Reward Processes

Forms of Rewards
Individual:
Basic pay, incentives, Benefits Rewards attendance, performance, competence

Team:
Team Bonus Rewards group co-operation

Organization:
Profit sharing ESOPS (Employee Stock Options Program) Gain sharing

Types of Rewards
Intrinsic rewards: Intrinsic rewards are less tangible, originate from persons or job itself and reflect Herzberg motivators. Example of such factors includes;
Variety in Job Content. Sense of being a part of value adding process. Believe that they are valuable members of a team. Increased responsibility and autonomy. Sense of accomplishment Participation in setting targets and opportunities to achieve them. Feed back information. Recognition. Opportunities to learn and grow.

Extrinsic rewards: Results from the actions of others, such as supervisions are more easily controlled by managers. Examples include
pay, fringe benefits, praise and promotion.

Compensation Trends in India

There has been a significant increase in basic salary, hence deferred benefits. Companies have restricted non-tax perks in the form of reimbursement under various heads Mainly focused at certain higher levels Companies provide higher annual increments. There has been a shift in incentives to group\team incentives from individual based.

CONTD Company encourages employees to buy the cars themselves through hire-purchase and installments are paid by company. Medical benefits are common-tie up with insurance companies-annual medical checkup Companies sponsor employees for higher education. Companies reimburse books, periodicals etc. Club membership in form of reimbursement of one-time joining fee for one club plus the monthly/ annual subscription to one more clubs is an attractive perk for senior management. Companies also go for bulk corporate club memberships.

Contd
Substantial differentials in gross compensation of the managerial level to the next lower level Personalized salaries out of a basket of options for individuals at senior levels. Significant increase in basic salary and hence in deferred benefits. Soft furnishing allowance is being provided towards purchase of curtains, carpets, cutlery and crockery etc., and this is usually paid as an annual, non-taxable allowance. Conveyance is an area, which provides a lot of scope for variations. Practices with regard to provision of car, driver and reimbursement of expenses on car, parking, cleaning, petrol, and maintenance are covered under this category.

Housing loans or interest subsidy is also provided Reimbursement for travel for a holiday including accommodation in guesthouses, transit flats etc, is practiced. In most cases, this is used as a discretionary reward for exemplary performance rather than as a perk. Pre-employment benefits for attracting good people include the company picking up of all relocation expenses for the family, transport of personal goods, assistance in locating housing, schooling etc. Some trendy components like long-term paternity or maternity leave, part and flexi-time employment options are also available. The senior executives share introduction of profit sharing schemes whereby when the company earns profits beyond a certain fixed level, the profit accrued, the average norm being 20 to 25% of the excess profit. Stock options are also a rage in the market.

Laws Affecting Compensation in India

Workmen's Compensation Act, 1923 (WC Act) Payment of Wages Act,1936
The Payment of Wages (Amendment) Act, 2005

Minimum Wages Act,1948 Employees' State Insurance Act, 1948 Employees' PF and Miscellaneous Provisions Act, 1952 The Maternity Benefit Act, 1961 Payment of Bonus Act, 1965 Payment of Gratuity Act, 1972