Compensation management

COMPENSATION MANAGEMENT
MANPREET SINGH
Asst. Professor
GNA Business School

COMPENSATION
• Compensation is a wide range of financial and non financial
rewards to employees for their services rendered to the
organization. It is paid in form of wages, salary, other
benefits such as vacations, maternity leave, medical
facilities etc. compensation helps in motivating the
employees and reduce labor turnover.
• Compensation can also be defined as follows:
• 1. A system of rewards that can motivate the employees to
perform.
• 2. A tool that is used to foster values and culture.
• 3. An instrument that enables an organization to achieve its
objectives.

COMPENSATION MANAGEMENT
• Compensation Management is designing and
implementing total compensation package with a
systematic approach to providing value to
employees in exchange for work performance.
• Compensation is a systematic approach to
providing monetary value to employees in
exchange for work performed.
• Compensation may achieve several purposes
assisting in recruitment, job performance, and
job satisfaction

OBJECTIVES OF COMPENSATION
MANAGEMENT
1. To determine basic wage and salary
2. To Attract Top Talent
3. To Retain & Reward Personnel
4. To Boost Motivation
5. To Be Compliant
6. To Maximize ROI

• To Attract Top Talent
One of the primary goals of compensation should be to
recruit qualified talent. When you have a competitive
compensation plan in place, you’ll be better able to
attract top industry talent.
• To Retain & Reward Personnel
Don’t lose your top talent to your competitors because
employees believe that the grass will be greener
elsewhere. Find out market values for your employees
and pay accordingly. You can also set up pay-for-
performance models to drive performance by
encouraging associates to reach new goals and push
farther.

• To Boost Motivation
When structured effectively, your compensation plan can drive
motivation across your teams. Employees who know that they’re
being fairly compensated for their work feel appreciated and are
therefore more likely to stay engaged, committed, and productive.
A well-developed compensation plan can also increase job
satisfaction in general.
• To Be Compliant
• Compensation isn’t just about being fair within the industry; it must
also comply with federal regulations, such as the Fair Labor
Standards Act. While adhering to standards can complicate
your compensation management, it will help protect your company
against litigation and ensure fairness across the board for your
personnel.

• To Maximize ROI
• It requires some fine tuning, but compensation
management is most effective when you get the
biggest bang for your buck. In other words, if you
can create a compensation plan that stays within
budget while also driving productivity through
pay-for-performance and other motivational
tactics, you’re creating a plan that’s both
equitable for the company and advantageous for
hardworking employees.

STEPS FOR DETERMINING
COMPENSATION
1. Define the job.
2. Price the job.
3. Determine the job’s value to your
organization.
4. Review where a job fits within a grade/range.
5. Consider organizational factors, including
budget.

STEPS FOR DETERMINING
COMPENSATION
1. Define the job.
• Define the job’s purpose, essential duties and
responsibilities, required skills and knowledge,
experience, and educational level. This involves
creating a job description or updating an existing
one. When done right, defining a job accurately
requires a comprehensive job analysis. A job title
alone will not adequately define a job. You must
fully understand and document its
responsibilities.

2. Price the job.
• Particularly in the case of a new job, use salary survey information
(typically three sources) to price the job. Match the job description
to the jobs within your salary surveys – ideally it should match 60-
70% of the job duties. If a direct match doesn’t exist, price multiple
jobs in the survey and blend the data. In addition, match the
breakouts to the demographics of your organization to make sure
you are comparing the data against your competitors – such as
number of employees and industry type.
• Once matched, select a percentile based on
your compensation philosophy. If you are trying to pay
competitively at market for a given position, based on your
compensation philosophy, you will want to choose the median or
50th percentile. Once data from all three sources is collected, a
market average should be calculated. This is typically the “going
rate” (otherwise known as the market rate) for the position.

• 3. Determine the job’s value to your organization.
• Evaluating the job’s worth and value not only in the market, but
also to your organization, is an important step in setting
compensation for this reason: a job with greater internal impact
and contribution to your organization’s strategy and business
objectives will be more valuable, and therefore should be paid
more, than a job with less of a direct impact. Knowing the job’s
value also helps you determine whether or not compensation is
worth negotiating.
• When evaluating a job’s worth, several different methods can be
used. Jobs can be slotted into a class or grade that matches their
class description on job skill and complexity. Also, jobs can be
assigned points based on certain factors such as mental and/or
physical effort, supervisory responsibility, and
accountability/responsibility.

• 4. Review where a job fits within a grade/range.
• Depending on the value of the job and what it is priced at,
the job (if it is a new job) is then allocated to the pay
structure in a given grade. Existing jobs will already be
assigned to a grade and have a range if you have a pay
structure in place. Reviewing the compensation of other
jobs within the grade, pay rates of similar jobs and peers,
and the range of pay for those jobs will help you set
appropriate compensation.
• You’ll also want to consider experience level in the range.
Typically new-hires with no to little experience earn closer
to the minimum, and highly experienced employees earn
closer to the maximum

• 5. Consider organizational factors, including budget.
• Evaluate what is in your budget and what you paid the last
incumbent, if it is not a new role. You should also factor in projected
cost-of living adjustments, bonuses, and other increases.
• In addition, consider the mix of pay. Pay can include various forms
(variable pay, base pay, skill-based pay, etc.), depending on the
position. For example, sales and executive employees may have a
much different mix of pay forms than an administrative employee.
When setting compensation, it’s important to evaluate what that
mix should be based on market data and organizational needs.
• Also, recognize that pay is only part of the total rewards package. If
your organization offers many other attractive benefits like flexible
schedules, engaging career opportunities, fulfilling work, rewards
and recognition programs, and generous time off and benefits,
these can all factor into your pay decisions.

Internal factors
• Ability to Pay: The prosperous or big companies can pay
higher compensation as compared to the competing firms
whereas the smaller companies can afford to maintain their
pay scale up to the level of competing firm or sometimes
even below the industry standards.
• Business Strategy: The organization’s strategy also
influences the employee compensation. In case the
company wants the skilled workers, so as to outshine the
competitor, will offer more pay as compared to the
others.Whereas, if the company wants to go smooth and is
managing with the available workers, will give relatively
less pay or equivalent to what others are paying.

• Job Evaluation and Performance Appraisal: The job evaluation
helps to have a satisfactory differential pays for the different
jobs.The performance Appraisal helps an employee to earn extra on
the basis of his performance.
• Employee: The employee or a worker himself influences the
compensation in one of the following ways.
Performance: The better performance fetches more pay to the
employee, and thus with the increased compensation, they get
motivated and perform their job more efficiently.
Experience: As the employee devote his years in the organization,
expects to get an increased pay for his experience.
Potential: The potential is worthless if it gets unnoticed. Therefore,
companies do pay extra to the employees having better potential as
compared to others.

EXTERNAL FACTORS
• Labor Market: The demand for and supply of
labor also influences the employee
compensation. The low wage is given, in case, the
demand is less than the supply of labor. On the
other hand, high pay is fixed, in case, the demand
is more than the supply of labor.
• Going Rate: The compensation is decided on the
basis of the rate that is prevailing in the industry,
i.e. the amount the other firms are paying for the
same kind of work.

• Productivity: The compensation increases with the
increase in the production. Thus, to earn more, the workers
need to work on their efficiencies, that can be improved by
way of factors which are beyond their control.The
introduction of new technology, new methods, better
management techniques are some of the factors that may
result in the better employee performance, thereby
resulting in the enhanced productivity.
• Cost of Living: The cost of living index also influences the
employee compensation, in a way, that with the increase or
fall in the general price level and the consumer price index,
the wage or salary is to be varied accordingly.

• Labor Unions: The powerful labor unions influence the
compensation plan of the company. The labor unions are generally
formed in the case, where the demand is more, and the labor
supply is less or are involved in the dangerous work and, therefore,
demands more money for endangering their lives.The non-
unionized companies or factories enjoy more freedom with respect
to the fixation of the compensation plan.
• Labor laws: There are several laws passed by the Government to
safeguard the workers from the exploitation of
employers.The payment of wages Act 1936, The Minimum wages
act 1948, The payment of Bonus Act 1965, Equal Remuneration Act
1976, Payment of Gratuity Act 1972 are some of the acts passed in
the welfare of the labor, and all the employers must abide by these.

PAY STRUCTURE
• Salaries are paid by organizations to their employees in
exchange for the services rendered by them. The salary
paid to employees comprises of a number of different
components, such as basic salary, allowance, perquisites,
etc.
• Salary structure is the details of the salary being offered, in
terms of the breakup of the different components
constituting the compensation. Any change(s) to the salary
structure i.e. among the elements, can have a major impact
on what the employee does, such as the kind of tax
exemptions claimed. Knowledge of what makes up the
salary earned is crucial since it helps keep the employee
informed about how much goes into forced savings and
what kind of tax exemptions to claim.

Components of Pay/Salary Structure
1. Basic Salary
2. Allowances
• Dearness Allowance
• House Rent Allowance
• Conveyance Allowance
• Leave Travel Allowance
• Medical Allowance
• Books and Periodicals Allowance

3. Gratuity
4. Employee Provident Fund
5. Professional Tax
6. Perquisites
7. ESIC

• Basic Salary
• Basic salary is the base income of an employee,
comprising of 35-50 % of the total salary. It is a
fixed amount that is paid prior to any reductions
or increases due to bonus, overtime or
allowances. Basic salary is determined based on
the designation of the employee and the industry
in which he or she works in. Most of the other
components, like allowances, are based on the
basic salary. This amount is fully taxable.

Allowances
• Allowance is an amount payable to employees during the course of
their regular job duty. It can be partially or fully taxable, depending
on what type it is. Allowances provided and the limits on it will
differ from company to company, according to their policies.
• Dearness Allowance - Dearness allowance is a certain percentage
of the basic salary paid to employees, aimed at mitigating the
impact of inflation. It is paid by the government to employees of
the public sector and pensioners of the same.
• House Rent Allowance – A house rent allowance is that component
of the salary which is paid to employees for meeting the cost of
renting a home. It offers tax benefits to the employees for the sum
that they pay towards their accommodation every year. Salaried
individuals residing in rented homes can claim this exemption and
reduce their tax liability.

• Conveyance Allowance - Conveyance allowance, also known
as transport allowance, is a kind of allowance offered by
employers to their employees to compensate for their travel
expense to and from their residence and workplace. Note - In
Union Budget 2018, a standard deduction of Rs. 40,000 has
been introduced in lieu of transport (Rs 19,200) and medical
(Rs 15,000) allowances.
• Leave Travel Allowance - Leave travel allowance is eligible for
tax exemption. It is offered by employers to their employees
to cover the latter's travel expense when he or she is on leave
from work. The amount paid as leave travel allowance is
exempt from tax under Section 10(5) of Income Tax Act, 1961.
Leave travel allowance only covers domestic travel and the
mode of travel needs to be air, railway or public transport.

• Medical Allowance - Medical allowance is a fixed
allowance paid to the employees of an organization to
meet their medical expenditure. Note - In Union
Budget 2018, a standard deduction of Rs. 40,000 has
been introduced in lieu of transport (Rs 19,200) and
medical (Rs 15,000) allowances.
• Books and Periodicals Allowance - Books and
periodicals allowance is a type of allowance provided
to employees for helping them meet the expenses
associated with purchase of books, periodicals and
newspapers. It is tax exempt to the extent of actual
expenditure incurred towards purchase of books and
periodicals.

• Gratuity
• Gratuity is a lump sum benefit paid by employers to those employees who
are retiring from the organization. This is only payable to those who have
completed 5 or more years with the company. The gratuity amount is paid
in gratitude for the services rendered by the individual during the period
of employment. According to the Payment of Gratuity Act, 1972, gratuity
is calculated as 4.81% of the basic pay. Most firms with a workforce of 10
or more employees come under the Act.
• Employee Provident Fund
• Employee Provident Fund is an employee benefit scheme where
investments are made by both the employer and the employee each
month. It is a savings platform that aids employees to save a portion of
their salary each month, from which withdrawals can be made following a
month from the date of cessation of service or upon retirement. At least
12% of an employee’s basic salary is automatically deducted and goes to
the Employee Provident Fund every month. The contributions are
maintained by the Employees Provident Fund Organization (EPFO).

• Professional Tax
• Professional tax is a tax levied on the income earned by
salaried employees and professionals, including
chartered accountants, doctors and lawyers, etc. by to
the state government. Different states have varying
methods of calculating professional tax. The maximum
amount that is payable in a year is Rs. 2,500. Employers
deduct profession tax at prescribed rates, from the
salary paid to employees, and pay it on their behalf to
the State Government. The revenue collected is used
towards the Employment Guarantee Scheme and the
Employment Guarantee Fund.

• Perquisites
• Perquisites, also referred to as fringe benefits, are the benefits that
some employees enjoy as a result of their official position. These
are generally non-cash benefits given in addition to the cash salary.
Some examples of perquisites include provision of car for personal
use, rent-free accommodation, payment of premium on personal
accident policy, etc. The monetary value of perquisites gets added
to the salary and tax is paid on them by the employee.
• ESIC
• If a company has 10 or more employees (20 in case of Maharashtra
and Chandigarh) whose gross salary is below Rs. 21,000 per month,
then the employer is required to avail ESIC scheme for such
employees. The employer's contribution will be 4.75% of gross
salary, whereas the employee's contribution will be 1.75% of gross
salary.

WAGE
• A wage is compensation paid to employees for work
for a company during a period of time. Wages are
always paid based on a certain amount of time. This is
usually an hourly basis. This is where the term hourly
worker comes from. Other forms of compensation
include salary and commissions.
• What Does Wage Mean?
• Lower level employees are paid based on the amount
of time worked. These employees usually have a time
sheet or time card to keep track of the hours worked
per week. Most modern employers have computerized
systems to keep track of hourly employee hours.

Wage Differentials
• The wage paid to workers varies greatly. These wage
differentials are mostly the result of differences in
worker ability and the workers' effort in performing the
job, but may also result if the job is unionized, since
the goal of labor unions is to increase compensation
over and above what would otherwise be provided
based on free market conditions. There are also wage
differentials across occupations, because of differences
in the demand and supply of laborers for particular
jobs or occupations. These differences arise primarily
because of differences in the amount of education or
training required and in the desirability of the job itself.

INCENTIVES
• Incentive refers to performance linked
compensation paid to improve motivation and
productivity. It is the monetary inducements
offered to employees to make them perform
beyond the acceptance standards.

OBJECTIVES OF INCETIVE PLAN
(i) To use wage incentives as a useful tool for securing a
better utilisation of manpower, better productivity
scheduling and performance control, and a more effective
personnel policy.
(ii) To improve the profit of a firm through a reduction in
the unit costs of labour and materials or both.
(iii) To increase a worker’s earning without dragging the
firm into a higher wage rate structure regardless of
productivity.
(iv) To avoid additional capital investment for the
expansions of production capacity.

PROFIT SHARING
• Profit sharing is an organizational incentive plan
whereby companies distribute a portion of their profits
to their employees in addition to prevailing wages.
Profit sharing can generate benefits to the company by
fostering greater employee cooperation, reducing labor
turnover, raising productivity, cutting costs, and
providing retirement security. Profit sharing gives
employees a direct stake in the profitability of a
company, creating an atmosphere in which employees
want the business to succeed as much as management
does

Employee Stock Options Plans
• Many companies use employee stock options plans to compensate,
retain, and attract employees. These plans are contracts between a
company and its employees that give employees the right to buy a
specific number of the company’s shares at a fixed price within a
certain period of time. The fixed price is often called the grant or
exercise price. Employees who are granted stock options hope to
profit by exercising their options to buy shares at the exercise price
when the shares are trading at a price that is higher than the
exercise price.
• Companies sometimes revalue the price at which the options can
be exercised. This may happen, for example, when a company’s
stock price has fallen below the original exercise price. Companies
revalue the exercise price as a way to retain their employees.

SOCIAL SECURITY
• The Social Security Act provides a range of programs to
afford you a basic level of benefits in the event of your
retirement, death, or disability. Most of these benefits
are financed by payroll taxes.
• Social security is that security which the society
furnishes through appropriate organization against
certain risks or contingencies to which its members are
exposed. These risks are essentially contingencies
against which the individual cannot afford by his small
means and by his ability or foresight alone.

Features of Social Secirity
• Mechanism to solve the problem of insecurity.
• It is a group effort in place of individual effort.
• Protect the workers from various
contingencies of life.
• It is collective effort of employee, employer,
and govt.
• Idea to provide social justice.

Objectives of Social Security
(1) Security and stability of living
(2) Support to individuals for independence
(3) Support of household functions
It also provides:
• 1. Compensation
• 2. Restoration
• 3. Prevention

1. Security and stability of living
• the present objective of social security is to
ensure the entire citizens sound and anxiety-
free lives through implementing social
security systems to help them in case of
instability of living and to prevent such
instability.

• 2) Support to individuals for independence
• "Independence" generally means to lead an independent
life without receiving supports or controls by others, to lead
an independent life without relying on others' help despite
physical disabilities, or to lead a mentally independent life
even physically needing others' help.
• Although it is basically required for each one to lead an
independent life for himself/herself, unforeseen events
such as illness and accidents, corporate bankruptcy, or
physical weakness in his/her old age may hinder the
maintenance of independent living. Besides there are some
people who cannot live independently and need others'
help because of disabilities by nature.

• (3) Support of household functions
• Some of the social security systems are taking over the functions
that have been privately fulfilled by each household including the
care of children in need of such care, care of persons (children) with
disabilities, rearing children and giving support to aged parents.
Outsourcing under the social security systems of such functions has
become necessary for the following reasons. The traditional
household infrastructure has been weakened due to the increase in
the number of nuclear families and to the downsizing of family
scales; the living environment and people's values on living have
been changing; and the average life span of Japanese people has
been prolonged. Because of these, some of the household
functions can no longer be privately met and need to be supported
by the society.

• Compensation:
• Compensation ensures security of income. It is based on this consideration
that during the period of contingency of risks, the individual and his/her
family should not be subjected to a double calamity, i.e., destitution and
loss of health, limb, life or work.
• Restoration:
• It connotates cure of one’s sickness, reemployment so as to restore
him/her to earlier condition. In a sense, it is an extension of
compensation.
• Prevention:
• These measures imply to avoid the loss of productive capacity due to
sickness, unemployment or invalidity to earn income. In other words,
these measures are designed with an objective to increase the material,
intellectual and moral well-being of the community by rendering available
resources which are used up by avoidable disease and idleness.

Functions of Social Security
(1) Social safety device
(2) Redistribution of income
(3) Diversification of risks
(4) Social stability, and economic stability and
growth

• (1) Social safety device
• Social security functions as a social security device (social safety
net) for ensuring stable and anxiety-free lives in preparation against
difficulties that might endanger the stability of living such as illness,
injury, need for care, unemployment, retirement without means to
earn money, and unforeseen accidents.(Note)
• For example, in case of illness or injury, you can easily receive
medical services with the medical expenses paid by medical
insurance. Even if you retire from your work and have lost the
means to earn money yourself, you can receive old-age pensions to
lead a stable life. Besides for the needy who cannot be supported
by other social security systems, the public assistance system
ensures them the minimum level of living.

• (2) Redistribution of income
• Under the free economy in which individuals and companies are
engaged in economic activities basically at their discretion, each
person basically earns income as rewards for his/her production
activities. The income levels differ by person, reflecting his/her
ability, efforts, positions, etc. The trends of the market economy,
however, may not always result in the fair distribution of income to
which everyone can be satisfied with. For example, the labor
market is more restricted for people with disabilities and for the
elderly than for general workers, and the wage levels are generally
lower. For a family with a parent and an infant, the income may be
low due to the restrictions on the working hours. If a worker gets ill
or injured by an accident and can no longer work, he/she will lose
the means to earn money. Besides due to the inheritance system,
there are differences in people's assets regardless of their efforts.

• (3) Diversification of risks
• The basic principle of society is for each one to be
independent and to take action at his/her own risk. There
may often happen, however, unforeseen events that
individuals cannot deal with for themselves such as illness,
accidents and unemployment. Social security provides a
mechanism for the entire society to deal with such
uncertain risks in people's daily lives, and contributes to the
diversification of risks by minimizing the influence exerted
by a risk through provision of capitals, etc. It can be said
that social security can fulfill its function as a social safety
net by effectively promoting the diversification of risks and
the redistribution of income.

• (4) Social stability, and economic stability and growth
• As shown in (1) to (3) above, social security has the function to stabilize
society and the government by giving a feeling of security to people, giving
support when they actually become difficult to live, or redistributing
income to reduce earning differentials.
• Besides social security mitigates economic fluctuations for economic
stability, and supports the growth of economy. For example, continuous
provision of fixed amounts of money even in the periods of economic
depression as under the public pension system not only stabilizes the lives
of old people but also mitigates economic fluctuations (as built-in
stabilizer) by encouraging consumption based on pensions as financial
resources. Furthermore, the reserve for pensions held under the public
pension system has been utilized as the financial resources for fiscal
investments and loans to fund the improvement of social capitals and the
economic development.

• The Social Security (Minimum standards)
Convention No. 102 of the International Labour
Organization prescribes the following
components of social security:
• (a) Medical care
• (b) Sickness benefit
• (c) Old age or retirement benefit
• (d) Employment injury benefit
• (e) Family benefit
• (f) Maternity benefit
• (g) Survivor’s benefit

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