Unit IV (Part – III)

Compensation
Syllabus:
✓ Compensation – Concept and Policies
✓ Components of Employee Remuneration
✓ Methods of Wage Payment
✓ Incentive Plans – Types
✓ Fringe Benefits
✓ Executive Compensation
Compensation
❑Compensation literally means to counter-balance.
Compensation is what employees receive in
exchange for their contribution to the organization.
❑According to R. Wayne Mondy, “Compensation is
the total of all rewards provided to employees in
return for their services. The overall purpose of
providing compensation are to attract, retain and
motivate employees”.
❑ According to Gary Dessler, “Compensation means
all forms of pay or rewards going to the employee
and arising from their employment”.
❑ Compensation management helps the organization
to obtain, maintain and retain a productive
workforce.
❑ Employee compensation includes all forms of pay
going to employees and arising from their
employment. It has two main components:
❑ Direct Financial Payments i.e., pay in the form
of wages and salaries, incentives and
commissions and bonuses.
❑ Indirect Financial Payments i.e., financial
benefits such as employer-paid insurance and
vacations.
Principles Governing Compensation Management

Individual
Worth

Compen-
sation

External Internal
Equity Equity
Internal Equity Motivation

External Equity Perceptions of Fairness Compensation

Individual Worth Performance

❖This principle acknowledges that factors or
variables external to the organization influence
the level of compensation in an organization.
❖Variables include among others:
❖Supply and Demand of Labour
External ❖Market Rates
❖The principle of external equity ensures that
Equity jobs are fairly compensated in comparison to
similar jobs in the labour market.
❖If these variables are not kept in consideration
while fixing wage and salary levels, these may
be insufficient to attract and retain employees
in an organization.
❖Organizations have various jobs which are relative
in terms of value or worth, i.e., various jobs in
organizations are comparative.

Internal ❖This relative worth of jobs is a certain by job

evaluation.
❖An ideal compensation system should establish
Equity and maintain appropriate differentials based on
relative values of jobs.
❖Compensation system should ensure that more
demanding jobs are paid more.
❖According to this principle, an individual
should be paid as per his her performance.
❖The compensation system, as far as possible,
Individual should enable the individual to be rewarded
according to his contributions to the
Worth organization.
❖This principle ensures that each individual's
pay is fair in comparison to others doing the
same job, i.e., ‘equal pay for equal work’.
Performance
Effort

Determinants Seniority
of Rewards Skills held
Job Difficulty
Discretionary Time
Equity in Compensation

Enhancing Individual and Organizational Efficiency

Employee Motivation and Retention

Objectives of
Goodwill in the Labour/Talent Market – Strong Employer
Compensation Brand
Management Adherence to Laws and Regulations

Controlling HR Cost

Improving Industrial Relations

Rewards
Components of
Total Intrinsic Extrinsic
Compensation
Participation
in decision- Financial Non-Financial
making

Job freedom/ Preferred

Performance Membership
office
Autonomy Based Based
furnishing

More Flexible work

Piece work Basic Pay
Responsibility schedules

More
Dearness Preferred
Interesting Commission
Allowance leave
Work

Opportunities
House Rent
for personal Incentive Pay Own secretary
Allowance
growth

Diversity of Performance Protection Impressive

activities Bonus programmes Job Titles

Merit pay Pay for time Conveyance

plans not worked facilities

Medical care
Components of Compensation
❑ Wage and Salary (Basic Pay): Although the terms ‘wage’ and ‘salary’ are often used
interchangeably; the term ‘wages’ is more appropriate for remuneration paid to ‘blue
collar’ workers, the term ‘salary’ is more appropriate for ‘white collar’ employees. The
International Labour Organization (ILO) defines the term ‘wage’ as “the remuneration
paid by the employer for the services of hourly, daily, weekly and fortnightly employees”.
‘Salaries’ are usually paid to clerical, executive and managerial personnel, usually on a
monthly rate of pay, irrespective of the number of hours put it. Wages and salaries are
subject to annual increments. They differ from employee to employee and depend on
the nature of the job, type of industry, seniority and merit. Dearness Allowance may
often form a part of ‘basic pay’.
❑ Allowances: Organizations pay various allowances to compensate employees for
inflation, housing or special conditions of their jobs in addition to basic pay. These usually
include: Dearness Allowance (although it is sometimes considered as part of basic pay),
Market Allowance, House Rent Allowance, Hardship Allowance, etc.
Components of Compensation (continued)
❑ Incentives: Incentives are additional payments to employees besides the payment of
wages and salaries. Often these are linked to productivity, either in terms of higher
production or cost savings or both. Hence, incentives are often referred to as ‘payment
by results’.
❑ Fringe Benefits: Fringe benefits include such benefits which are provided to employees,
either (i) having long-term impact such as provident fund, gratuity, pension or (ii) on the
occurrence of certain contingencies/events viz., medical benefits, accident relief, health
and life insurance, or (ii) for the facilitation of performance of job such as uniforms,
subsidized canteens, recreational facilities, etc.
❑ Perquisites: These are normally provided to managerial personnel either to facilitate
their job performance or to retain them in the organization. Such perquisites may, among
others include company car, club membership, free residential accommodation, paid
holiday trips, stock options, etc.
Components of Compensation (continued)
❑ Non-financial Benefits: Non-financial benefits are those aspects of the total rewards of
an employee that do not affect them (or nominally affect them) in monetary terms but
motivate them for higher performance by making their work-life more pleasant and
enjoyable. While financial incentives are indeed important to employees they alone may
fail to motivate employees beyond a certain level. In terms of Herzberg’s Motivation
Theory, financial incentives are by and large ‘maintenance’ or ‘hygiene’ factors (related
to the job-context), which if not present would demotivate employees. Non-financial
benefits on the other hand tend to act as ‘motivators’ (related to the job content).
Types of Non-Monetary Rewards
❑ TREATS
❖ Free Lunches
❖ Festival Bashes
❖ Coffee Breaks
❖ Dinner with the Boss
❖ Dinner for the Family
❖ Picnics
❖ Birthday Treats
❑ KNICK-KNACKS
❖ Desk Accessories
❖ Company Watches
❖ Tie pins, Broaches
❖ Dairies/Planners
❖ Calendars
❖ Wallets
❖ T-Shirts
Types of Non-Monetary
Rewards (contd.)
❑ TOKENS
❖ Movie Tickets
❖ Vacation Trips
❖ Coupons Redeemable at Stores
❖ Early Time-offs
❖ Anniversary/Birthday Allowances/Presents
❑ OFFICE ENVIRONMENT
❖ Redecoration
❖ Corner Office/Office with window
❖ Flexible Hours
❑ AWARDS
❖ Trophies
❖ Plaques
❖ Citations
❖ Certificates & Scrolls
❖ Letters of Appreciation

This Photo by Unknown Author is licensed under CC BY-NC

Types of Non-Monetary Rewards (contd.)
❑ ON-THE JOB
❖ More responsibility
❖ Job rotation
❖ Special Assignments
❖ Training
❖ Representing the company at public fora
❑ SOCIAL ACKNOWLEDGEMENT
❖ Informal recognition
❖ Recognition at office get togethers
❖ Friendly greetings, smiles, e-mails
❖ Solicitation of advice and/or suggestions
❖Use of company facilities for company projects
Methods of Wage Payment
In devising a system of wage determination, the critical question is whether the
wage will be linked to the time spent at the workplace or the output achieved
during a specified period of time. Accordingly, there are two broad methods of
wage payment, namely ‘Time wages’ and ‘Piece Wages’. Each method has its own
relative benefits and drawbacks.

METHODS OF
WAGE PAYMENT

TIME WAGE PIECE WAGE BALANCE

METHOD METHOD METHOD
Time Wage Method: In this case, the wage is determined on the basis of the time
worked which may be hourly, daily, weekly, monthly, or any other time base. A
worker is paid wages for the time worked irrespective of his output during that time.
It is the oldest and most prevalent system of wage payment.

MERITS DEMERITS
▪ Suitable for jobs where output per specified period ▪ Employees tend to become lax in their work as
of time is difficult to measure. there is no direct link between performance
▪ Easy to understand and calculate. efficiency and wages.
▪ Both employers and employees know in advance ▪ As the system does not discriminate between
the amount of wages payable/receivable over a efficient and inefficient workers, efficient workers
time period and can adjust their budgets/plans are demotivated.
accordingly. ▪ The total labour component of the cost of
▪ Ensures the payment of regular and certain amount production for a batch becomes difficult to
of wages which is beneficial from the social point of determine as total wages is not linked to output.
view.
▪ Product/service quality does not suffer because of
workers trying to produce/work recklessly as it
sometimes happens in case of piece wages.
Piece Wage Method: In this case, workers are paid wages according to the
quantity of output during a specified period. This may be calculated on the basis of
the number of units produced or the completion of a job where output is not
measurable in terms of individual units.

MERITS DEMERITS
▪ Direct relationship between output and wages ▪ In the absence of any standardized procedures
works as a motivating factor to workers to produce there arises problems in fixing the piece rate.
more. ▪ There is a tendency on the part of the employers to
▪ Differentiates between efficient and inefficient lower the piece rate if workers’ earnings become
workers and provides incentive to inefficient very high.
workers to improve their efficiency. ▪ Does not ensure ‘minimum wages’ as output may
▪ May be considered as ‘fair and equitable’ so far as be adversely affected by factors beyond workers’
utilization of human resources are concerned. control.
▪ Requires less supervision in terms of workers ▪ Product/service quality suffers because workers
taking excessive breaks. prioritize quantity over quality.
▪ Easy to estimate the cost of a job or batch as total ▪ Workers may damage machinery and equipment as
wages is directly proportional to output. they tend to become reckless.
▪ Leads to jealousy and inter-personal conflicts.
▪ Opposed by trade unions as it promotes disunity
among workers.
Balance Method
❑ This is also known as the debt method. It is essentially a combination of time wage and
piece wage methods. Under this method, the worker is guaranteed a fixed wage based
on time rate with a provision for piece wages at elevated levels of efficiency.
❑ Thus if a worker produces more quantity in a period, usually on weekly or monthly basis,
and earns more on piece-rate system than he would have under time rate, he is given
credit for the additional output which is compensated in another period during which
production quantity falls below time wage.
❑ This method provides a sense of security to a worker so far as his wage earnings is
concerned. At the same time he is also motivated to produce more because of the
inclusion of the piece rate system.
Incentive Plans
❑ Financial incentives are either in direct monetary form
or measurable in monetary worth that are provided to
employees to motivate them for superior
performance.
❑ The ILO refers to incentives as ‘payments-by-results’.
❑ Incentives include all those payments which are in
addition to their base pay. Such payments enhance an
employee’s financial well-being.
❑ Unlike wages and salaries, which are relatively fixed,
incentives generally vary from individual to individual,
and from period to period for the same individual.
❑ Incentive schemes may applied on individual basis or
group basis.
Incentive Schemes

Earnings vary in the Earnings vary less Earnings vary more Earnings differ at
same proportion as proportionately than than proportionately different levels of
output output than output output

Taylor’s Differential
Straight Piece Work Halsey Plan High Piece Rate
Piece Rate

Merrick’s Differential
Standard Hour Rowan Plan High Standard Hour
Piece Rate

Gantt task and Bonus

Barth Scheme
System

Emerson’s Efficiency
Bedeaux Point Plan
Plan
Fringe Benefits
❑ Fringe benefits include employee benefits and services in addition to direct
remuneration .
❑ Fringe benefits are a form of indirect compensation because they are
usually extended as a condition of employment and not directly related to
performance.
❑ Fringe benefits and services are not linked to employees’ productivity but
are provided to different classes of employees either as a matter of
statutory requirement or on a voluntary basis or as a combination of both.
❑ The term fringe benefits is difficult to define because the items that are
included in this category show great variation. Yet the following three
criteria may be used to classify any benefit or service given to the
employees as a fringe benefit:
1. It should be computable in terms of money.
2. The amount of money is generally not predetermined.
3. No contract, indicating when the sum is payable , should exist
(although there are some exceptions to this criterion).
Objectives of Fringe
Benefits
Fringe benefits are instrumental in accomplishing certain social human
relations macroeconomic goals. The main objectives of fringe benefits may
be as follows:
1. To meet the needs of employees and safeguard them against certain
hazards of life, particularly the ones which an individual especially of
small means cannot himself provide for.
2. To attract and retain employees.
3. To earn the gratitude and loyalty of employees.
4. To enhance ‘employer brand image’ employers need to remain
competitive in the market with regard to provision of fringe benefits.
5. To enhance overall corporate image.
6. To seek meaningful cooperation of employees in production process.
Objectives of Fringe Benefits
(contd.)
7. To infuse confidence, motivate and boost morale
of employees.
8. to reduce rate of absenteeism and labour
turnover.
9. to reduce the influence of trade unions .
10. reduce statutory interference
11. to improve human and industrial relations
12. to promote employee welfare and provide
improved work environment.
Benefits
to
Workers

Significance of
Fringe Benefits
FRINGE
– Fringe BENEFITS
benefits benefit Benefits
Benefits
all stakeholders to Society
to
Employers
in an industry.
Benefits to workers/employees
i. Reduce gap between nominal wages and real wages.
ii. Provide contentment to them.
iii. Improve their standard of living.
iv. Maintain their self respect.
v. Make them more responsible and committed.
vi. Help them in their growth and development.
Benefits to Employers
i. Present attractive areas of negotiation when large wages and salary
increases are not practical.
ii. Help attracting and retaining employees.
iii. Reduce the influence of trade unions on workers.
iv. Help in reducing cost of production.
v. Help in reducing wastage.
vi. Help in increasing productivity.
vii. Help in improving quality.
viii. Enhance the image of the organization.
ix. Help in reducing the rate of absenteeism.
x. Help in reducing supervisory expenses.
xi. Improve human and industrial relations.
Benefits to Society
i. Availability of goods and services at reasonable
prices.
ii. Increase in gross national production.
iii. Educational upliftment.
iv. Promotion of peace and harmony.
v. Improvement in standard of living.
vi. Reduction of social cost.
Types of
Fringe
Benefits

Payment for Welfare & Old Age &

Employee Safety &
Time Not Recreational Retirement
Security Health
Worked facilities Benefits

Retrenchment Safety Subsidized Provident

Paid Holidays
Compensation Measures Canteens Fund

Deposit
Lay off Workmen’s Credit
Shift Premium Linked
Compensation Compensation Societies
Insurance

Health
Paid Vacation Housing Gratuity
Benefits

Employee Medical
Counselling Benefit

Welfare
Pension
Organizations

Holiday
Homes
Components of Fringe
Benefits Educational
Facilitates

Parties &
Picnics
Executive Compensation
- Concept
❑ Who qualifies as an executive for the purpose
of ‘executive compensation’?
For the purpose of executive compensation, an
executive is a person who is a member of the
highest decision-making group in an organization.
Chief Executive Officer (CEO), Full-time
directors/Executive directors, and other top
managers (particularly those just one level below
the board of directors) fall into this category.

❑ Why are ‘executives’ paid handsome pay

packages? What is the justification?
The top managers’ role and performance are
crucial to the survival and growth of the
organization. It is, therefore, essential to offer
them satisfactory compensation packages in order
to attract and retain talented executives.
Executive compensation is a matter of intense debate across
the globe, both inside and outside the organization, it is
different from the compensation of other employees in the
following ways:
1. Executives play a major role in designing their own pay-
packages.
Why is the 2. Executive compensation often forms a substantial
portion of the operating costs of an organization.
‘executive pay’ 3. Executives frequently operate under bonus and stock
decision is different option plans that can dramatically increase their total
from the compensation.
compensation plan 4. Executives are often offered such perquisites that are
not available to other categories of managerial
of other employees? personnel.
5. Higher levels of executive compensation is paid to
motivate them to higher levels of performance.
However, it is difficult and too subjective to determine
performance efficiency of executives objectively.
6. Executives often have the benefit of a ‘golden
parachute’, i.e., either a ‘severance compensation’ or a
guaranteed position in the newly created entity (in cases
of mergers).
Factors affecting
Executive Compensation
❑ Job Complexity
❑ Required Competency
❑ Organization’s Capacity to Pay
❑Organizational Philosophy towards
Executive/Talent Retention
❑ International HR Practices (particularly for
MNCs)
❑ Legal Provisions (where they exist)
ALIGNING ATTRACTING AND ENHANCING THE

Objectives of MANAGERIAL
INTEREST WITH
OWNERSHIP INTEREST
RETAINING THE MOST
TALENTED AND
COMPETENT
MOTIVATION,
INVOLVEMENT,
COMMITMENT AND

Executive EXECUTIVE PERSONNEL LOYALTY OF

EXECUTIVES

Compensation
Packages
PROMOTING ENSURING FINANCIAL ENCOURAGING
MANAGERIAL SECURITY AND CONTINUOUS
EFFICIENCY COMPENSATING FOR DEVELOPMENT OF
THE ELEVATED LEVELS SKILLS AND
OF RISKS BORNE BY COMPETENCIES
EXECUTIVES
Components of Executive Compensation
Packages
Executive Basic Salary
Compensation
Annual Bonus Plan
Managerial Commission
Stock Options
Long-term Incentives
Executive Perks
Pension Schemes
Severance Pay
Basic Salary
❑ Although basic salary is a key component of
executive compensation packages, it is usually
not a major portion thereof as most executive
pay packages emphasize more on ‘performance-
based’ pay and incentives.
❑ Basic salary is still important as it forms the
basis for computing some other components of
the pay package. (For instance, bonus and
dearness allowance may be expressed as
percentage of salary.
❑ Prior to deciding the basic salary, organizations
usually undertake job evaluation exercises for
assessing the worth of managerial jobs.
However, job evaluations may not be very
useful, when an organization opts for
‘competency-based’ pay , i.e., executives paid
for their skills and abilities rather than the
demands of the job.
Annual Bonus Plans
❑ Typically, a profit-making organization offers bonus
schemes to its managers as a part of the compensation
package.
❑ The bonus is considered a short-term performance-
linked incentive scheme. It is computed and paid on the
basis of the performance of a singe year.
❑ Under a usual bonus plan, an organization may pay
bonus to managers when they achieve the performance
standards. They may not get any bonus till they achieve
those specified performance standards.
❑ Bonus schemes can be classified on the basis of
performance measures, performance standard and pay-
performance relationship structure.
❑ Organizations may use one or more performance
measures for determining bonus. However, accounting
profits (like EBIT, revenue growth and operating income)
invariably form an important financial measure.
❑ Organizations may also use non-financial performance
measures like goal accomplishment by managers as a
basis for determining bonus plans.
Managerial Commission
❑ It is a performance-based incentive scheme.
❑ The commission payable to managerial personnel
is viewed as an important technique for in
achieving the required level of motivation,
involvement and efficiency among managers.
❑ The primary purpose of managerial commission is
to encourage managers to keep expenses under
control and improve revenue.
❑ However, the Companies Act puts a ceiling on the
amount of commission payable to executives.
Executive Perks
❑ It is a unique kind of benefit payable to the top managers as
recognition for their contribution to the growth of the
organization.
❑ An important prerequisite for deciding executive perks is
determining the job worth of the executives. Usually executive
perks are allowed to a select group of key executives.
❑ Typically perks to executives include, among others:
❑ Company car and chauffeur
❑ No cost parking
❑ Limousine Service
❑ Kidnapping and ransom protection, bodyguards
❑ Counselling services, including financial and legal services
❑ Travel for spouse and children
❑ Club Memberships
❑ Use of company credit cards
❑ Medical expense Reimbursement
❑ Reimbursement/Payment of Children’s educational
expenses
❑ Interest free loans or loans at concessional rates of
interest
Stock Option Plan
❑ It is a unique compensation plan in which the managerial
personnel get the right to buy stocks (mostly equity shares)
of their company in the future at a price which may be
equal to or less than the price prevailing at the time of
purchase.
❑ The stock option is normally a non-tradable long-term
incentive available to managers.
❑ The option to buy the stocks would normally lapse when
the executive leaves the organization for any reason.
❑ The stock option is an effective executive compensation
scheme available to organizations to create ownership
interest for managerial personnel. The purpose of stock
options is to encourage managers to accept increased
responsibility for their decisions involving the future of the
organization.
❑ The stock option is an effective motivational instrument for
managers if there is continuous increase in share prices. In
contrast, it may not be as effective when there is declining
trend in share prices.
Long-term Incentive Plans (LITPs)
❑ In addition to stock option schemes, an organization may also
employ other long-term reward schemes for enhancing the
performance, involvement and commitment of executives. The
aim of long-term incentive plans is to enhance the
performance-pay relationship considerably.
❑ Normally, organizations impose specific performance
conditions on the managers for getting long-term incentives.
❑ LTIPs can be calculated on the basis of cumulative performance
of managers on a multi-year cycle (typically an average of three
to five years).
❑ Performance unit or share is one of the most common forms of
LITP. As per this incentive scheme, a manager would be entitled
to specific cash or shares as reward as the reward in the event
of completing the performance targets successfully.
❑ Though LITPs are generally tied to overall organizational
performance, they may also be linked to group performance
within the organization.
Pension Schemes and
Severance Pay
❑ Some companies have pension schemes
specially designed for company executives.
❑ Many companies provide severance pay
for executives, either as a lumpsum or in
the form of continued payment of
compensation after the expiry of contract.