C OM P E N S AT I O N

M A NA G E M E N T
UNIT 6
Compensation

Imagine you are CEO

You have to guide your HR to make a compensation
policy for the organisation.
What are the aspects you will include and exclude in
the policy?
How do you ensure the fair pay to employees?
 Compensation Management

Compensation refers to all forms of financial returns: tangible

services and benefits employees receive as part an employment
relationship, which may be associated with employee’s service to the
employer like provident fund, gratuity, insurance scheme and any
other payment which the employee receives or benefits he enjoys in
lieu of such payment.
 Definition
• According to Dale Yoder, “Compensation is paying people for work.”
• “Compensation is what employees receive in exchange for their contribution to
the organization.” – Keith Davis
• In the words of Edwin B. Flippo, “The function compensation is defining as
adequate and equitable remuneration of personnel for their contributions to the
organizational objectives.”
 Compensation structure in India

The Code of Wages – Governs compensation, worker benefits, minimum

wage, and other compensatory-related topics

Industrial Relation Code – Sets rules on issues like unions, strikes,

hiring and employee termination

Occupational Safety, Health, and Working Code – Focuses on creating a

standardized workplace with safe working conditions

Code on Social Security – Covers the various employee benefits workers

are entitled to.

 Pre-requisites for Effective Compensation Management
• Adequate: Minimum governmental, union, and managerial pay level positions must be met by the compensation

system.

• Equitable: Care should be taken so that each employee is paid fairly, in line with his/her abilities, efforts,

education, training, experiences, competencies, and so on.

• Balanced: Pay, benefits, and other rewards must provide a reasonable compensation package.

• Secure: Employees’ security needs must be adequately covered by the compensation package.

• Cost-Effective: Pay must be neither excessive nor inadequate, considering what the enterprise can afford to pay.

• Incentive Providing: The compensation package should be such that it generates motivation for effective and

productive work.

• Acceptable to all Employees: All employees understand the pay system well and feel it is reasonable for the

enterprise and the individual.

 1.Acquire qualified personnel.
2.Retain current employees.
3.Ensure equity.
4.Reward desired behavior.
Objectives of 5.Control costs.
Compensation 6.Comply with legal regulations.
Management 7.Facilitate understanding.
8.Further administrative efficiency.
9.Motivating Personnel.
10.Consistency in Compensation.
11.To be adequate.
 Compensation Evaluation

Change in
Compensation
Systems
Traditional Modern
Compensation Compensation
System System

Compensation
System
Compensation
Strategy
Incentives: Drivers in attracting the best employees
 Case of Compensation Management

The northern division of Gautam Appliances met every month to Analyze its targets and
the actual sales. Shravan Kumar, a jovial and friendly manager who was respected by all
the sales personnel, headed the meeting. His suggestions and other contributions during
the meetings always helped sales personnel exceed their targets. He also gave a patient
listening to employee problems and suggestions. During one such review meeting, one of
the sales executives, Pavan Kumar, raised the issue of the uniform compensation system
being implemented by the management.
What shall we do? How do we proceed?
 Theoretical
Understanding
 Theories of Compensation

1. Reinforcement and Expectancy Theories

The reinforcement theory postulates that a behavior which has a

rewarding experience is likely to be repeated. The implication for
remuneration is that high employee performance followed by a
monetary reward will make future employee performance more likely.
 2. Vroom’s expectancy theory

Like the reinforcement theory, Vroom’s expectancy theory focuses on the link between rewards and
behavior. Motivation, according to the theory, is the product of valence, instrumentality and expectancy.
Remuneration systems differ according to their impact on these motivational components. Generally speaking,
pay systems differ most in their impact on instrumentality the perceived link between behavior and pay.
Valence of pay outcomes remains the same under different pay systems. Expectancy perceptions often have
more to do with job design and training than pay systems.
 3. Equity Theory

Adam’s equity theory says that an employee who perceives inequity in his or her rewards

seeks to restore equity. The theory emphasizes equity in pay structure of employees’

remuneration.

Employee’s perceptions of how they are being treated by their firms are of prime importance

to them. The dictum ‘a fair day work for fair day pay a sense of equity felt by employees.

When employees perceive inequity, in can result in lower productivity,

higher absenteeism or increase in turnover.

 Equity

 Internal Equity:

The employee perceives the fairness in different pay for different jobs based on the nature of work involved, i.e. he must feel that pay

differentials among the jobs are fair.

 External Equity:

The employee should feel the fairness in what they are being paid is in line with what other players in the same industry are paying to their

employees for the same kind of job.

 Individual Equity:

The employee perceives the pay differentials among the individuals who are performing the same kind of a job and within the same

organization. Usually, an individual with more experience gets high remuneration as compared to the fresher irrespective of the nature of a job.
 4. Agency Theory

The agency theory focuses on the divergent interests and goals of

the organization’s stakeholders and the way that employee remuneration can be used to align
these interests and goals. Employers and employees are the two stakeholders of a business unit, the
former assuming the role of principals and the latter the role of agents. The remuneration payable to
employees is the agency cost. It is natural that the employees expect high agency costs while the
employers seek to minimize it. The agency theory says that the principle must choose a contracting
scheme that helps align the interest of the agents with the principal’s own interests. These contracts
can be classified as either behavior-oriented (e.g. merit pay) or outcome oriented (e.g. stock option
schemes, profit sharing, and commission).
 THE COMPONENTS OF “IN-HAND” PAY

1. Basic ---- The basic salary. It is paid out every month and is
taxable
2. Dearness Allowance (DA) --- It compensates for increases in the
cost of living due to inflation and is taxable.
3. Incentives/bonuses ---- Paid out depending on employee
performance. Paid out monthly and fully taxable.
4. Conveyance allowance ---- Paid out to meet expenses on
commuter related transportation. It is paid out monthly. Up to
Rs 800 per month is tax-free. Any amount over that is taxable.
House Rent Allowance (HRA) ---- HRA is paid out to meet full or part of an expenditure on renting a
house. It is usually expressed as a percentage of basic. It is paid out monthly and can be tax-free
depending on certain conditions.
Medical allowance ---- Medical allowance is paid out to help with the amount that is spent on medical
treatment and medicines. It is paid out monthly. An alternative is if the employee presents his/her
employer with actual receipts for medical care. In this case they are paid in full by the company, tax-
free up to Rs 15,000 per year.
Leave Travel Allowance of Concession (LTA/LTC) ---- LTA is paid to encourage periodic vacations. It
is paid out once a year and can be tax-free provided certain conditions are met.
Vehicle Allowance --- This is given to maintain a car. It is paid out monthly and is taxable.
Telephone/Mobile Phone Allowance --- It is given to maintain a landline or cell phone. It is paid out
monthly and is taxable.
Special Allowance ---- As if all the above is not enough, this allowance can be given out to pay money
that doesn’t fit into any other category. This allowance is paid out monthly and is taxable.
 Praveen Metals Case
In a speech to the employees, the chairman of Praveen Metals said that to survive
in the dynamic market, they must be able to switch gears and perform differently in
response to change. According to him, traditional job titles and descriptions
indicated a restricted set of work duties. Paying employees according to these
structured duties led to rigidity during times of change.
Which one is the best?
Change the structure, keep the same compensation package
Change the structure, Change the compensation package?
Is there any other system of compensation package to be introduced?
 External and Internal Factors Affecting
Employee Compensation

11.
Compensatio
10. Cross n Survey.
Sector
9. Mobility

External
Globalization
8. Legislation

7. Labour
Unions
6.
Government
5. Society Control

4. Prevailing
Wage Level
3. Economic
Conditions
2. Cost of
Living
1. Demand
and Supply of
Labour
 Internal Factors

1.
Compensation 5. The 7. Employee
Policy of the 3. Worth of a Organizational Related
Organization Job Ability to Pay Factors.

2. Employer’s 4. Employee’s 6. Job Analysis

Affordability Worth and Job
Description
and
Linking Employee
with Position
COMPENSATION PLAN
Straight Salary/No Commission

Salary Plus Commission

Commission Only

Draw Against Commission

Profit Margin

Territory Volume

Capped Commission

Performance Gate

Set Rate
 HOW IS COMPENSATION DETERMINED?

Required
Industry average Availability of
experience and Job title and Job location and Company size and
pay of similar qualified
education level of responsibilities cost of living reputation
jobs candidates
position
 Situation

A computer software and services company's compensation plan had three

components: commission, product bonuses, and business plan objectives.
The company's sales staff was tasked with many activities that were
unrelated to selling. Sales reps felt they didn't have time to sell, be
productive, or make more money with this added administrative burden.
Because they were on a commission plan, they did not like the idea of
being dependent on the “draw” much of the time.

what would you do to solve this problem?