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

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.

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

a. Internal Alignment- aligning pay with the contributions of employees in achieving
organizational objectives
b. External Competitiveness- aligning pay with competitors calculate the risk of being
competitive
c. Employee Contribution- considers contribution to performance as a factor of pay, putting a
high premium on employee contribution
d. Management of the Pay System- putting a system of giving of compensation. It considers
timeliness of pay.
COMPONENTS OF A COMPENSATION SYSTEM
Job Analysis
- The process of determining all the information specific to a particular job.
- It provides the required behavior to perform the tasks, and the performance standards
needed to evaluate job performance.
- It determines the knowledge required such as accounting procedures and the work
conditions relevant to the job such as work schedules and physical setup
- It is necessary for the development of job descriptions, which are essential in determining
pay rates.
Job Description
- The written summary of all the duties and responsibilities of a particular job position. It
includes the job specification which describes the educational background, experience,
skills, and personal traits that are needed to perform a particular job.
- Job analysis is done to write job descriptions for all jobs in the organization.
Job Evaluation.
- It is the process of determining the worth of a job. 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.
- It helps 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
- It helps 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 is based on the theory of population by Thomas Malthus. According to this
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 will not be able to work.
- 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 and outputs.
- 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
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 greatest 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 on the Internet. Because of this
information, organizations are sometimes wary of 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 the 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. It is the place where workers and employees
interact with each other. In the labor market, employers compete to hire the best, and the
worker compete for the best satisfying job.
Labor Supply. The number of hours people are willing and able to supply at a given wage rate
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. It describes the amount of demand for labor that an economy or firm is willing
to employ at a given point in time. The demand for workers is dictated by employers.