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Unit I
Importance of Pay
Pay represents by far the most important and contentious element in the
employment relationship, and is of equal interest to the employer,
employee and government

to the employer because it represents a significant part of his

costs, is increasingly important to his employees' performance and to
competitiveness, and affects his ability to recruit and retain a labour
force of quality;

to the employee because it is fundamental to his standard of living

and is a measure of the value of his services or performance;

to the government because it affects aspects of macro-economic

stability such as employment, inflation, purchasing power and socioeconomic development in general.

While the basic wage or pay is the main component of compensation,

fringe benefits and cash and non-cash benefits influence the level of
wages or pay because the employer is concerned more about labour costs
than wage rates per se. The tendency now is towards an increasing mix
of fringe benefits, which therefore have an important impact on pay
levels. In industrialized countries, and sometimes in countries with high
personal tax rates, the non-pay element of executive compensation has
substantially increased in recent years.
Objectives of Pay
Pay determination may have one or more objectives, which may often be
in conflict with each other. The objectives can be classified under four
broad headings.

The first is equity, which may take several forms. They include income
distribution through narrowing of inequalities, increasing the wages of
the lowest paid employees, protecting real wages (purchasing power), the
concept of equal pay for work of equal value. Even pay differentials based
on differences in skills or contribution are all related to the concept of
A second objective is efficiency, which is often closely related to equity
because the two concepts are not antithetic. Efficiency objectives are
reflected in attempts to link a part of wages to productivity or profit,
group or individual performance, acquisition and application of skills
and so on. Arrangements to achieve efficiency may be seen also as being
equitable (if they fairly reward performance) or inequitable (if the reward
is viewed as unfair).
A third objective is macro-economic stability through high employment
levels and low inflation, for instance. An inordinately high minimum wage
would have an adverse impact on levels of employment, though at what
level this consequence would occur is a matter of much debate. Though
pay and pay policies are only one of the factors which impinge on macroeconomic stability, they do contribute to (or impede) balanced and
sustainable economic development.
A fourth objective is the efficient allocation of labour in the labour
market. This implies that employees would move to wherever they receive
a net gain; such movement may be from one geographical location to
another, or from one job to another (within or outside an enterprise).
Such movement is caused by the provision or availability of financial
incentives. For example, workers may move from a labour surplus or low
wage area to a high wage area. They may acquire new skills to benefit
from the higher wages paid for skills. When an employer's wages are
below market rates employee turnover increases. When it is above market
rates the employer attracts job applicants. When employees move from
declining to growing industries, an efficient allocation of labour due to
structural changes takes place.
The need for a Compensation StrategyFor any / all of the following reasons:

1 To attract and retain the best in the industry

2 To have compensation strategy aligned to each business to better
serve independent business needs
3 Should attract lateral hires
4 Need for greater flexibility in taking compensation decisions
5 Need to align employee career movement
6 Adding value through personnel costs
1 Capable applicants are attracted towards the Organization and it
helps acquire qualified competent personnel
2 To retain current employees so that they do not quit
If compensation levels are not competitive, it will result in
higher turnover
3 Motivate employees to perform better
4 Encourage value added performance
Reward the desired behaviour
5 Control costs
Through a rational compensation system, employees can be
obtained and retained at a reasonable cost
6 Promoting continuous development through competence related
and skill based pay schemes, effective performance management
7 Promoting teamwork through team pay
8 Promoting flexibility by replacing hierarchical and rigid pay
9 Providing value for money by evaluating the costs as well as
benefits of reward management practices
10 Facilitating easy understanding by all, including employees,
operating managers and HR personnel
11 Providing value for money by evaluating the costs as well as
benefits of reward management practices
12 Easy administration
1 Be congruent with and support corporate values, beliefs,
philosophy and culture
2 Emanate from business strategy and business plans (medium and
long term)
3 Fit the desired management style

4 Provide the competitive edge required; be based on an industry

benchmarking study
5 Be based on an Organizations ability to pay
6 Be adaptable to changing business conditions
7 Ensures Equity both internally and externally
8 Complies with the legal regulations as imposed by the government
9 Is effectively communicated
10 Careful selection of performance measures, determination of
performance awards and distribution mechanisms
11 Union participation and involvement in designing the policy to
facilitate comprehension and acceptance
12 Provisions for modifications and periodically reviewed

Organization Philosophy / Culture

Career Progression
Benefits to Employees
Individual v/s Team Focus
Performance Recognition giving the message to align Total
COMPENSATION with Business Situation, Needs & Goals
6 Generate Flexibility / Variability of Costs
7 Focus on Effectiveness of Total Compensation Policy

Organization Mission, Vision, Goals & Values

Inclination towards People Development, Attraction &
Retention of Talent


Inter / Intra Level Relativity, Compa Ratio


Assess Competitiveness Current & Targeted

Percentile Positioning

Paying Ability

Budget Considerations


Parity: External equity (prevalent pay structures in industry /
geographic location)
Demand and supply: of labour and market condition
Geographic location: cost of living and inflation
Philosophy: mission, vision, goals & values inclination towards
people development, attraction & retention of talent, goodwill &
organization culture
Parity: internal equity (relevant differentiating factors performance,
seniority, skills, responsibilities, interpersonal abilities, individual
vs. Team vs. Organization roles)
Paying ability: budget considerations / financial implications /
limits of ability to pay; business performance
Legalities: compliance of statutory and government requirements
Trade unions: influence in collective bargaining
Fringe benefits: statutory (overtime payment, canteen subsidy,
employee provident fund, gratuity) & non-statutory (conveyance
allowance, LTA, loans, insurance)
1. Job related: job requirements and internal consistency
2. Competition: availability of special competent personnel
3. Flexibility: due to varied levels of competencies and skills of
4. Responsibilities: individual productivity and performance /
contribution to output
5. Individual assessment: qualifications and relevant experience
Allocation, conversion, and transfer of a portion of the income of an
organization to its employees for their monetary & in-kind claims on
goods & services
A Monetary claims are wages or salaries paid to an employee in the
form of money / or a form that is easily and quickly transferable to
money at
the discretion of the employee


Wages & salaries in the form of money could be 2 types:

present payments (earned & acquired at present time) &
deferred payments (earned but not acquired until some
future time)
Coins / paper money / cheques, credit cards
Stock option plans / pension plans / post retirement income
In-kind claims are claims on goods & services made available & paid
for either totally or in some percentage by the employer
in lieu of money provide an equivalent value for what has
been offered & received
little or no immediate monetary gain
organizations purchase the usually desired goods & services
to take advantage of
1. Economies of scale available through group purchasing
2. The benefits available through tax laws & regulations
3. Government laws requiring certain services

Situation related rewards, related to the physical & psychological well
being of each employee, these rewards satisfy the emotional & intellectual
- Impact on the intellectual, emotional & physical well-being of the
- money provided in short term (weekly / monthly / annual
bonuses & awards)
- permits employees to pay for goods & services desired
- depends on: job requirements; outputs that meet or exceed
quantity, quality & timeliness standards; innovations
leading to
improved productivity; dependability; loyalty
- includes: base pay, premiums & differentials, short term
merit pay, travel expenses, clothing reimbursement etc
- days off with pay for holidays, longer paid vacations, election
official, witness in court, paternity leave, maternity leave,

time off
to vote, personal leave, relocation payments, lunch &
rest periods
- although they increase labour costs, but they enhance quality
work life opportunities for most employees
- job security is a prime consideration
- loss of job could be due to any of the following:
* accident
* sickness
* personal performance
* interpersonal dynamics problems
* firms decline / end
- unemployment insurance, supplemental unemployment benefits
(subs), severance pay, job contract etc help unemployed
subsist until new employment opportunities arise
- health or accident disability can lead to non performance of
normal assignments
- family expenses persist
- social security, workers compensation, sick leave, travel accident
insurance, accidental death and dismemberment, short &
long-term disability plans are provided
- providing income after retirement
- includes social security, pension plans, profit sharing (long term),
stock option plans
- funds invested in these draw tax-free interest thus employees can
defer tax obligations
- Providing dependents with income when an employee dies or is
unable to work due to total and permanent disability
- life insurance plans, social security, pension plans, workers
Income continuation & payment for the expenses incurred
for overcoming the illness / disability
wide variety of insurance plans available
medical, hospital, surgical insurance (for self & dependents)
major medical, dental & vision care. hearing aid, post8

retirement medical plans, prescription drugs, visiting nurse

liability related insurance: group legal, group automobile,
group umbrella liability, employee liability
- Perks or perquisites
- tax free: charitable contributions, giving of gift, employee
assistance programs, counseling, child adoption, child /
care, subsidized food service, discounts on merchandise, fitness
programs, parking, commuting assistance (transportation
to &
from work), fly first class, professional memberships, professional
journals, special relocation & moving allowances, pay for spouse
on business trips, home entertainment allowance, domestic staff
allowance, mobile phone, use of assistant for personal services
- Tax favoured: medical expense reimbursement, chauffeur driven
car, company plane / yacht, company provided facilities, personal
use of credit cards, vacation accommodation, special loan
arrangements, club membership, concierge services

Enhance dignity and satisfaction from work performed

- Least expensive & most powerful rewards
- Employee recognition leads to self - worth & pride
- Employees should feel that they are needed & their efforts are
being appreciated

Enhance physiological health, intellectual growth, and

emotional maturity
Provide a safe working environment: provision of safe
equipment, risk free environment, minimization of noxious fumes,
avoidance of extreme heat, cold & humidity conditions, elimination
of contact with radiation & other diseaserelated materials,
reduced noise levels, clean workstation,
stress & technological advancements affect emotional wellbeing of the individual: providing a stable & secure lifestyle,
training & development opportunities to overcome health-related

Promote constructive social relationships with


an inexpensive & valuable reward is a work environment where

trust, fellowship & loyalty emanate from the top levels of
management, percolating to the grassroots
- comradeship of workplace associates
opportunity to develop productivity promoting social
- moving towards team based operations

Design jobs that require attention and effort

- restructuring job tasks to make it challenging
- sense of accomplishment from work
- job rotation to increase flexibility
- turning supervisors to mentors
- making jobs more interesting & less repetitive
Organizations increase quality & productivity; reduce employee turnover,
absenteeism, tardiness, waste of physical resources, theft & malicious

Allocate sufficient resources to perform work assignments

- all necessary human, technical and physical resources should be
made available to support & aid the employee in accomplishing
the assignment
- the organization must enable employees to gain the required
skills & knowledge necessary to perform the assignment
- organization should do everything possible to assist the employee
in completing the assigned work successfully

Grant sufficient control over job to meet personal demands

employee participation in decision-making process

casual dress day

scheduling work activities

flexible work schedules: compressed workweeks,

flextime programs, work from home choice

job sharing (2 part-time employees share 1 full-time


Offer supportive leadership & management

employee faith & trust in management

skill & interest in coaching & counseling of employees

praise for a job well done

constructive feedback leading to improvement in job


sufficiently flexible leadership with policies, rules,

regulations so that an employee can meet job responsibilities

without infringing on rights & opportunities of other employees

Fixed cash compensation
- largest component of the total compensation & rewards package
- monetary remuneration based on time worked & not on output /
- base wages & salaries depends on the internal value
by job evaluation) & external value (through market
pay surveys)
of employee
- after-tax paycheck
- determines lifestyle of the employees
- leisure activities restricted / defined by the paycheck
- most critical part of the four components

Wage & salary add-ons

- monetary remuneration
- paid over & above the salary
- includes payments for working overtime, shift differentials,
premium pay for working on holidays / weekends
- least critical of the four components

pay- for - output system
performance pay linked to both the company & the
difficult to measure in the service industry which employs
of the workforce of the total employed people
in several professions, it is difficult to measure output & pay

Employee benefits & services

- hidden payroll or fringe benefits
- indirect financial & non-financial payments
- supplementary compensation totally dependent on organizational

- includes benefits provided by an employer to his employees & his

family (in some cases)
- benefits for employment security; health protection; old age &
retirement; personnel identification, participation & stimulation
- two types: mandatory employee benefits: voluntary benefits
Employer is compelled to provide for certain benefits by the
operation of the law
Paid holidays factories act, 1948 a weekly paid holiday
Paid vacations one day for every 20 days worked
Retrenchment compensation industrial disputes act, 1947
(one month notice or one months pay) paid @ 15 days wage for
every completed year of service with a maximum of 45 days wage in
a year
Lay-off compensation - industrial disputes act, 1947
50% of the total of the basic wage & da for the period of their layoff) paid upto 45 days in a year
Workmens compensation workmens compensation act,
1923 payment to meet the contingency of invalidity & death of a
worker due to employment injury or occupational disease
Health benefits employee state insurance act, 1948
sickness benefit, maternity benefit, disablement benefit,
dependents benefit, medical benefit
Canteen facility factories act, 1948 canteen in factories
employing more than 250 workers
Provident fund contributions by employer & employee are
8.5% of basic salary benefit payable on retirement, voluntary
separation or death
Employee pension scheme introduced in 1995 employer
contribution is directed to pension + 1.66% of employee wages
contributed by central govt.
Entitled to pension @ 1 / 70th of salary for each
year of service
Gratuity after 5 years of continuous service 15 days
salary per year of service upto a ceiling of INR 3,50,000/Companies with more than 10 employees
Given in case of separation, superannuation, death or
No contribution of employees towards this benefit

PSU scheme public sector scheme

Various pension schemes with accrual rates varying
from 1/100 to 1/60
Both employer & employee contribute
Membership is mandatory for all those in PSUs
Leave encashment scheme claim encashment of unutilized
leave at the termination of service
Not-taxable in the hands of the retired employee
Payable to dependents in case of death of employee
Its is entirely the choice of the employer to provide these benefits
to the employees
Shift premium for IInd & IIIrd shifts for the odd hours
Company housing accommodation some companies even
pay for the utility bills (electricity / water & society charges)
Subsidized food & transport
Group mediclaim / personal accident insurance adequate
coverage for the hospitalization expenses incurred due to illness,
disease or injury sustained in accident / pregnancy (for female) for
employee & immediate family dependents
Educational facilities sponsor higher education of
employees & family members
For certifications / trainings / memberships etc
co-operative credit societies for fostering self-help than
going to money lenders
Legal aid provide legal assistance & aid through company
lawyers or others as & when required
Recreational facilities gyms, clubs, internet caf, one film
per week shows etc
Regular meetings & gatherings of employees with their
families to express talent, creativity & relieve of work stress
Loans at subsidized rates of interests for housing deposits,
vehicle purchase, marriage, illness or death of a close family
Personal health care extensive health check-up periodically
cellular phones / laptop on basis of business requirement
Corporate credit card to take care of official expenses
arising out of business trips
Gifts on various occasions like birthday, anniversary,
festivals to strengthen bond between employer & employee





1 Average salary hike in 2006 for India at 14%, making it the highest
in Asia Pacific

2 Employees in management staff cadre received average salary hike

of 16% in 2006
1 Employee expectations are on the rise
2 Senior/ Top Management received the highest percentage of
variable pay in their compensation in the range of 17% to 30%
3 Variable Pay increasing in year 2006 Banking Sector from 13% to 24%
IT from 13% to 18%
Manufacturing from 10% to 16%
FMCG from 14% to 18%
1 International Educational Advancement Program & Tuition
2 Signing Bonus
3 Investment company makes on Employee & Training imparted
(National/ International)
4 OPPORTUNITIES OF LEARNING Early responsibility in career,


freedom at work and innovate

JOB PROFILE Work Content, Challenging Assignments
our own timber
FUTURE PLANS OF COMPANY Growing organization
TREATMENT OF PEOPLE Strong values of trust, caring, fairness
and respect within organization, healthy relationship at work.


Changing environmental pressures
Three changes having impact on organization structure & management
Product markets have become global
increased competition in domestic & foreign markets
Rapidly changing technology
greater need to employ technically & professionally skilled
keep their knowledge base & competencies current

Fast changing demographic composition of Workforce

* higher age group of employees, more women employees,
rising level of formal education
Organizations response
Major changes in organization structure & management systems
new model: flat, flexible, team-based, participative, diverse,
quality- focused, dynamic, globally-oriented

changes in the job from being specialized & stable

horizontal growth of employees
new approaches to compensation & rewards
Employees are paid according to their number of skills
- skills are grouped in skill-blocks as an employee acquires each
block, his pay goes up
- skill block includes different types of skills:
**breadth skills which focus on all related jobs in an


integrated production process

**depth skills which aim to increase specialization in a
particular area
**vertical skills which are generally possessed by managers
Advantages to organizations
a workforce is created that can perform multiple tasks
organization gets flexibility to rotate employees & take care
of organization menaces like absenteeism, overtime,
turnover, work-flow interruptions due to production
bottlenecks and variations in product demand
better problem solving capability
improved productivity & quality of services/ products
stronger employee commitment
employees become familiar with the operations & tend to
recognize the value their own contributions

Advantages to the employees

acquire more self-control over their own earnings
develop greater capacity for self-management
experience more varied and enriched task assignments
these contribute to job satisfaction to a great extent
Delayering of pay structure
- a typical pay structure consists of grades & ranges
- a grade is a grouping of jobs falling within a certain range of
evaluation points
- attached to grades are pay ranges minimum to maximum
* successively higher grades will have higher minimum &
higher maximum pay rates
- pay structure typically consists of a tall hierarchy of narrowly
defined grades, each with a relatively limited pay range
* such structures create in employees a strong motivation to
strive towards upward mobility as a means to obtain higher
compensation rewards
Broadbanding is defined as
- Consolidation of existing pay grades into a small number of wide

results in broad minimum-maximum pay spread for each band
compared to conventional pay structures, broadband structures
have fewer bands & broader pay ranges
best suited to the needs of flexible, flatter & performance-oriented
organizations of today
Allow flexibility in moving employees between jobs within a band
without formal job titles & pay grade changes
Flat structures place increased emphasis on lateral career moves &
skill development that can be rewarded through broadbanding
Greater scope for pay growth through within- band-pay increases
than through promotions to a higher band

Example1 of how broad banding works

Band I - Executives, entry-level staff
Band II - Sr. Executives, supervisors, coordinators
Band III - Assistant managers
Band IV - Managers, business managers
Band V - General managers, national managers
Band VII - President & CEO
Example2 of how broad banding works
In a HR consultancy firm there are 3 bands across the
organization with a wide pay range in the same band:
- Entry level: requires good quantitative skills, knowledge of basic
MSOffice, ability to analyze & ability to learn fast
- Proficiency level: skills in project management, problem-solving,
resource management, thorough subject knowledge
- Mastery level: a leadership position requiring visionary skills &
ability to give direction to the organization
To move up the ladder, the employee needs to add value that would
clearly separate his accountability & key performance indicator
*here advancement means adding newer competencies
Defined as
- financially measurable reward paid to an individual based on his
overall performance
- a powerful tool that enhances employee productivity &

- These are awarded to teams or groups based on their collective
performance in achieving the assigned targets
- periodically targets are monitored to encourage improved productivity &
- provide each member an opportunity to receive a bonus on the output
of the team a whole
- most appropriate when jobs are inter-related
- generally payouts are determined by team rankings (based on criteria
like ratings by internal & external customers, achievement of quarterly
team objectives & the management input recognizing special
- within same team also, all members do not receive same payout it is
subject to peer evaluation
- major problem in this is designing a model team-based pay system

Steps for setting up team rewards

Appraising teams
to evaluate the performance of team against kras / preset
communicate the results to ensure transparency
measure the performance of the team (actuals vs. Targets)
every month
rewarding teams
Make the minimum level of performance the benchmark of
team reward
make team performance mandatory for individual rewards
distribute the team reward in proportion to the basic pay of
the grade to which each team member belongs
build a geometric rate of progression of the award for each
successive target
link the individual award to the basic pay of the grade to
which the individual belongs
The corporate buzzword today
Becoming a more common method for rewarding employees while

linking their performance more closely to the employers financial

Some companies are allowing all levels of employees to participate
in these programs
Variable pay is an innovative way to bring wages and salaries in
line with companies market performance
A simple concept thats based on rewarding employees for
increased sales or efficiency
rewarding employees who increase productivity or efficiency
provides incentive for other employees who want to share in
the bounty
rather than rewarding every employee with a pay raise or
bonus, variable pay rewards the individual worker, or a team
of workers, for extraordinary efforts
Indian companies increasingly adopting VPLP
more than 85% organizations having VPLP

Objectives / Benefits of VPLP

A powerful tool to enhance employee productivity & thus impact

align rewards to business goals

build a high-performing organizational culture

links overall compensation strategy with the organizations

business strategy

helps differentiate between a mediocre & a star employee

a very effective motivational technique

helps team members understand their job expectations


a valuable retention tool

helps upgrade skills of team members by inducing a

competitive environment
Types of Plans
Individual Based Pay
Individual-based plans are the most widely used
Of the individual-based plans commonly used, merit pay is by far
the most popular
- its use is almost universal
- merit pay consists of an increase in base pay, normally given once


a year
- supervisors ratings of employee performance are typically used
determine the amount of merit pay granted
- once a merit pay increase is given to an employee, it remains a
part of that employees base salary for the rest of his or her
tenure with the firm
Team based pay
Normally reward all team members equally based on group
these outcomes may be measured objectively or subjectively
the criteria for defining a desirable outcome may be broad or
as is less commonly done in individual-based programs,
payments to team members may be made in the form of a
cash bonus or in the form of non-cash awards such as trips,
time off, or luxury items

Plant wide / company based pay

Plant-wide or company-wide pay-for-performance plans reward all
workers in a plant or business unit on the basis of the
performance of the entire plant or business unit
profit and stock prices are generally not meaningful performance
measures for a plant or unit because they are the result of the
entire corporations performance
most corporations have multiple plants or units, a factor that
makes it difficult to attribute financial gains or losses to any single
segment of the business
- therefore, the performance indicator most frequently used to distribute
rewards at the plant level is plant or business unit efficiency, which is
normally measured in terms of labor or material cost savings compared
to an earlier period or another plant or business unit
They are the broadest type of variable-pay incentive programs
Reward employees on the basis of the entire corporations

the most widely used program of this kind is profit sharing.

Profit sharing is a company-wide pay-for-performance plan that
uses a formula to allocate a portion of declared profits to employees

typically, profit distributions under a profit-sharing plan are


used to fund employee retirement plans

Features of VPLP
Can be in cash or kind
generally offered in terms of extra perks as soft housing
loans, company cars, junkets abroad, mediclaim policies
If overall company performance is poor, SBU / team
performance does not warrant VPLP
Largely, it does not exceed 30% of an executive s annual pay
Minuses of VPLP
Recalculations in the case to reward nonexempt (hourly) employees
VPLP requires employers to include certain types of variable
compensation, such as bonuses, in employees regular hourly
wage rates
as a result, companies that pay variable compensation to
nonexempt employees must often recalculate employees
regular hourly pay rates by factoring in the variable pay
the recalculation then affects the overtime pay calculations
employers who are designing variable compensation
programs that include nonexempt employees must be sure to
review their programs.
failure to do so could cost significantly more in penalties
and payment of back wages
Unspoken assumptions
Several underlying assumptions are behind the variable-pay concept,
which derive from the very nature of the society that we live in and are
not necessarily accurate:
- money motivates people to work harder
- increased motivation will increase performance
- fair measurement of work performance is possible
Money as a motivator
there is no doubt that money can be a powerful motivator
however, it isnt always
Performance measurement

motivation is clearly linked to performance

however, in many cases motivation is not the problem
- the performance problem may be due to lack of skills, poor
organization, bad strategy etc
- measuring performance is difficult and the most significant
practical problem in VPLP
- even harder to manage is the problem of perception: even where
there are real, perhaps obvious, performance differences, the
employee who doesnt perform well is more likely to attribute his or
her low output to favoritism rather than performance

Failure of this motivational technique due to
inadequate planning
poor implementation
poor communication of details of the scheme across the
undefined evaluation method
individual objectives are not quantified for variable
pay calculation
Effective implementation by
-well defined individuals & group targets
-effective communication of the scheme to the employees
-commitment from the top
-effective performance-evaluation mechanism
* simple, measurable performance criteria that is understood
by all
-timely payouts

Employers need to do a better job of mapping individual employee

performance and linking it with compensation
To create and implement an efficient variable-pay plan, an employer must
make a commitment to define employee expectations in behavioral and
measurable terms
- This means making goals achievable, profitable, and practical for
both the company and its workers
- the key to the success of variable compensation is to have

something you can measure and understandsomething that is

linked to creating economic value for the company
instead of continually ratcheting up base pay, manufacturing and
service companies are adopting and expanding the use of incentive
compensation programs, at all levels, to reward outstanding
achievement without increasing fixed costs

EVA (Economic Value Added)

It is a performance metric that calculates the creation of
shareholder value
Eva is the calculation of what profits remain after the costs of a
company's capital - both debt and equity are deducted from
operating profit
True profit should account for the cost of capital
Steps to calculate EVA:
Calculate net operating profit after tax (NOPAT)
Calculate total invested capital (TC)
Determine a cost of capital (WACC)
Calculate EVA = NOPAT WACC% * (TC)
It is a financial performance method to calculate the true economic
profit of a company
Used for: setting organizational goals, performance management,
determining bonuses, communication with shareholders &
investors, motivation of managers, capital budgeting, corporate
valuation, analyzing equity securities (the non-debt securities of a
corporation representing an ownership interest)
Links employee performance with profits
It is the net operating profit minus an appropriate charge for the
opportunity cost of all capital invested in an enterprise
An estimate of true economic profit
Amount by which earnings exceed or fall short of the required
minimum rate of return that shareholders could get by investing in
other securities of comparable risk
Calculated by combining 3 factors: net operating profit after taxes,
capital & cost of capital
Continuous improvement in EVA brings continuous increase in
shareholders wealth since a sustained increase in EVA brings
increase in market value of the company
Incorporates 2 principles of finance into management decision

Primary objective of any company is to maximize the wealth

of its shareholders
The value of a company depends on the extent to which
investors expect future profits to exceed or fall short of the
cost of capital
NIIT, TCS & Godrej have implemented EVA in India
Across the world, Seimens, Sony, Whirlpool, Johnson & Johnson,
Cadbury, Bausch & Lomb have implemented EVA
New concept for productivity enhancement, investors confidence &
employee motivation
Steps for implementing EVAMeasuring of EVA concept defined & explaining throughout the
Managing through training programmes oriented to educate the
managers how they would earn in direct proportion to the wealth
that the company would make
Motivation of employee benefits / rewards through performance
linked remuneration scheme
Preparing mindset of employees in the long-run, to understand the
impact of EVA on their personal remuneration
Five Types:
Merit Pay
Stock Options
Merit Pay: An incentive plan implemented on an institutional wide basis
to give all employees an equal opportunity for consideration, regardless of
funding source. The merit increase program is implemented when funds
are designated for that purpose by the institution's administration,
dependent upon the availability of funds and other constraints. .
Allows the employer to differentiate pay given to high performers.
Allows a differentiation between individual and company performance.
Allows the employer to satisfactorily reward an employee for accomplishing a task
that might not be repeated (such as implementation of new systems).


Gainsharing: A technique that compensates

improvements in the company's productivity.




How does Gainsharing work?

A Company shares productivity gains with the workforce. Workers
voluntarily participate in management to accept responsibility for major
reforms. This type of pay is based on factors directly under a workers
control (i.e., productivity or costs). Gains are measured and distributions
are made frequently through a predetermined formula. Because this pay
is only implemented when gains are achieved, gainsharing plans do not
adversely affect company costs.
What are the 'Gains' that are measured?

Increases in production with equal or less effort.

Equal levels of production with less effort.

What are examples of Gainsharing formulas?

Calculate gain in hours: The actual hours worked minus the

expected hours (for the given level of output) equals the gain in


Helps companies achieve sustained

increases in productivity.
Employees become more involved the
productivity gains made by the
Employees can share in the benefits
organizational goals.
Leads to improvements in other
measures of company performance,
quality, lower rates of absenteeism,
defects, and "downtime."


Adherence to the FLSA requires

worker's "regular rate" of pay. To
overcome this limitation, employers
compensation to exempt employees.
The formulas and program may be
difficult to understand.
Requires a shift to a more team
oriented management style.

When does Gainsharing work best?

Works best when company performance levels can be easily quantified.
Employee involvement significantly enhances the effectiveness of

incentive pay. When used simultaneously, productivity gains from

combining these techniques can exceed gains achieved separately.
What is the best way to implement Gainsharing?
Meet with executives to develop a clear understanding of Gainsharing.
Develop various formulas and models to be used in predicting future
gains and the costs associated with sharing those gains. Prepare rules,
presentation materials, and dissemination of policy. Retrain supervisors
and administrators. Teams of employees are selected by peers to develop
cost-saving measures. Through their personal knowledge about their
jobs, employees are able to reduce waste and increase efficiency.
Profit Sharing: An incentive based compensation program to award
employees a percentage of the company's profits.
How does Profit sharing work? The company contributes a portion of
its pre-tax profits to a pool that will be distributed among eligible
employees. The amount distributed to each employee may be weighted by
the employee's base salary so that employees with higher base salaries
receive a slightly higher amount of the shared pool of profits. Generally
this is done on an annual basis.
Brings groups of employees to work
The pay for each employee moves up
together toward a common goal (the
or down together (no individual
success/benefit of the company).
differences for merit or performance).
Focuses only on the goal of
profitability (which may be at the
The costs of implementing the plan
expense of quality).
For smaller companies, these plans
rise and fall with the company's
may result in drastic swings in
earnings for employees which the
employees may find difficult to
organizational goals.
manage their personal finances.
Adherence to the FLSA requires
worker's "regular rate" of pay. To
overcome this limitation, employers
compensation to exempt employees.

When does Profit sharing work best? When company earnings are
relatively stable (or steadily increasing).

What is the best way to implement Profit sharing? Meet with

executives to develop a clear understanding of profit sharing. Develop
various formulas and models to be used in predicting future gains and
the costs associated with sharing those gains. Prepare rules.
Stock Options: The right to purchase stock at a given price at some
time in the future. Stock Options come in two types:

Incentive stock options (ISOs) in which the employee is able to

defer taxation until the shares bought with the option are sold. The
company does not receive a tax deduction for this type of option.


Nonqualified stock options (NSOs) in which the employee must

pay infome tax on the 'spread' between the value of the stock and the
amount paid for the option. The company may receive a tax deduction
on the 'spread'.

How do Stock options work? An option is created that specifies that the
owner of the option may 'exercise' the 'right' to purchase a companys
stock at a certain price (the 'grant' price) by a certain (expiration) date in
the future. Usually the price of the option (the 'grant' price) is set to the
market price of the stock at the time the option was sold. If the
underlying stock increases in value, the option becomes more valuable. If
the underlying stock decreases below the 'grant' price or stays the same
in value as the 'grant' price, then the option becomes worthless.
They provide employees the right, but not the obligation, to purchase
shares of their employer's stock at a certain price for a certain period of
time. Options are usually granted at the current market price of the
stock and last for up to 10 years. To encourage employees to stick around
and help the company grow, options typically carry a four to five year
vesting period, but each company sets its own parameters.
Allows a company to
In a down market,
share ownership with the
become valueless
Used to align the
interests of the employees
with those of the company.
operating income


Nonqualified Stock Options

Grants the option to buy stock at a fixed price for a fixed exercise period;
gains from grant to exercise taxed at income-tax rates
Aligns executive and
Dilutes EPS
shareholder interests.
investment is required
tax deduction.
May incent shorto

Restricted Stock
Outright grant of shares to executives with restrictions to sale, transfer,
or pledging; shares forfeited if executive terminates employment; value of
shares as restrictions lapse taxed as ordinary income
Aligns executive and
Immediate dilution
shareholder interests.
of EPS for total shares
investment required.
If stock appreciates
charged to earnings over
restriction period.
after grant, company's tax
deduction exceeds fixed
charge to earnings.

Performance shares/units
Grants contingent shares of stock or a fixed cash value at beginning of
performance period; executive earns a portion of grant as performance
goals are hit
Charge to earnings,
and shareholders if stock is
marked to market.
Difficulty in setting
performance targets.
investment required.
tax deduction at payout.

When do Stock options work best?


-Appropriate for small companies where future growth is expected. -For

publicly owned companies who want to offer some degree of company
ownership to employees.
What are important considerations when implementing Stock
-How much stock a company be willing to sell.
-Who will receive the options.
-How many options are available to be sold in the future.
-Is this a permanent part of the benefit plan or just an incentive.
Employee Stock Ownership Plan (ESOP): An ESOP is a defined
contribution employee benefit plan that allows employees to become
owners of stock in the company they work for. It is an equity based
deferred compensation plan. Several features make ESOPs unique as
compared to other employee benefit plans. First, only an ESOP is
required by law to invest primarily in the securities of the sponsoring
employer. Second, an ESOP is unique among qualified employee benefit
plans in its ability to borrow money. As a result, "leveraged ESOPs" may
be used as a technique of corporate finance.
An opportunity to buy stock at a set price some time in future for a
stated period
Stock option is the right or privilege to buy stock under an offer
valid for a stated period
A form of variable pay compensation package
Objectives of ESOPs
Instrument for attracting critical skills / highly valued or
scarce skills
Inculcates employee feeling of ownership and commitment
Creates additional wealth for employees
Supplement retirement / social security benefits
For employee retention particularly for groups apprehended of high
Helps introduce a performance management system without
incurring full cash out flow / lessening possible individual
differences in the immediate cash bonus

Enforces corporate governance

Infosys, Wipro, Maruti Udyog Limited, GE, Godrej, P & G, Zee Network,
Castrol etc have introduced ESOPs
Features of ESOPs
It is a qualified, defined contribution employee benefit plan that
invests primarily in the stock of the employer
A company has to create a trust fund for employees and funds it by
contributions of stock, cash or buy stock or cash to pay back the
ESOPs loan and to buy back stock in order to set-up a ESOP
Shares held by ESOP trust are distributed to the employees
through an employee option scheme
Return on an ESOP portfolio is linked to company performance
since investment is through employers securities
All employees except part-time directors are eligible to ESOPs of
the company
The terms, price & offer of ESOPs is done by compensation
committee of the board of directors
Options granted to employee are not transferable to any other
ESOP trust provides a warehouse for sponsoring companys shares
which can be sold or transferred to employees in future
Reservation up to 5% can be made by the issuer of the company
for employees of his company or promoters of the company
3 stages:
Grant of option (enable employee to purchase a certain number of
shares of the company stock at a determined price, usually within
a specified period of time)
Vesting (employee gets right to apply for the shares)
Exercise of option (on payment of exercise price, employee is
conferred the shares of the company)
There is a minimum period of one year between grant of options
and vesting of options & company shall have the freedom to specify
lock in period
Typically, lock-in period of 3-5 years with the provision that if
employee separates from the service of the company (except in the
case of death / medical incapacity), the shares would be forfeited &

reverted to the trust

Shares are not physically transferred to employees at this stage
Once the shares are transferred in favour of the employee, only
then the latter may decide to sell them in the market (this sale will
attract capital gains tax)
During the lock-in period, the shares registered in the name of the
employee would be kept in the custody of the trust
Types of ESOPs
One-off, uniform
An offer plan where the company may decide to include nonperformers, trainees, short-service staff, temps
A one-time allotment for an equal number of shares, options
or warrants to all at the market value
SEBI guidelines allow allotment of options below the market
price for shares, subject to the differential being accounted
in the books of the company
One-off, differential / discretionary
Also a one-off scheme where company may differentiate
allotments by grades, seniority or market value of special
Factors like achievements, potential, loyalty, hard work &
contribution to corporate performance if considered, then
the discretionary element will go up considerably
Ongoing schemes
Use a combination of uniform, differential & discretionary
allotments dynamically.
May be warrants, shares or options that can be issued as
sign-on bonus on confirmation / promotion /
superannuating / recognition of outstanding contribution
Given to some or all individuals
Have a vesting schedule
Are structured to enable flexibility
Proxy: stock appreciation rights / phantom shares
Notional units apportioned to employees
Are productivity / contribution linked incentive
programmes rather than stock option plans
An employee is allotted notional units / shares of the
company based on certain criteria at a set price
Employee is required to exercise his option within a given

period (say 2 years) when the share price is high & will be
eligible to draw the differential or the whole in cash on
deduction of tax
Provision is made to enable employees to decline the shares
& opt for the cash differential between the cost of exercise &
the market price
It would have the effect of a stock appreciation right /
phantom share
Some definitions
Phantom stock a bonus that rewards employees based on the
value of the companys stock & the dividend performance of the
Discount stock option stock option with an exercise price which
is less than the fair market value on the sale of the grant
Indexed stock option the exercise price is equal to the fair market
value at grant, but the price adjusts upward or downward
depending on an index (in relation to the market / industry / peer
group performance / any other measure)
Performance accelerated stock option has a fair market value
exercise price & a service based vesting schedule (longer than
traditional options which are generally for 10 years), but which
becomes exercisable at an earlier date in case specified
performance goals are achieved
Performance contingent stock has a fair market value price,
which becomes exercisable only when performance goals are
achieved. It lapses in case the set goals are not achieved
Purchased stock option down payment required to be made (% of
the market price) before the option may be exercised
Reload/restoration stock option stock option automatically
granted upon the exercise of a previously granted stock option to
the extent that the optionee uses shares rather than cash to pay
the purchase price of the original option (the exercise price of the
reload option is the fair market value on the date of the grant &
reload option expires on the same date as the original option
Variable - priced stock option with an exercise price that
fluctuates upward or downward in relation to stock price
performance (yo-yo stock option or indexed stock option)
Premium stock option exercise price greater than the fair market value
on the date of the grant

How does ESOP work?

The ESOP operates through a trust, setup by the company that accepts
tax deductible contributions from the company to purchase company

The contributions made by the company are distributed to

individual employee accounts within the trust.

The amount of stock each individual receives may vary according

to pre-established formulas based on salary, service, or position.

The employees may cash out after vesting in the program or when
they leave the company. The amount they may cash out may depend
on the vesting requirements.

When an ESOP employee who has at least ten years of

participation in the ESOP reaches age 55, he or she must be given the
option of diversifying his/her ESOP account up to 25% of the value.
This option continues until age sixty, at which time the employee has
a one-time option to diversify up to 50% of his/her account. This
requirement is applicable to ESOP shares allocated to employee's
accounts after December 31, 1986.

Employees receive the vested portion of their accounts at either

termination, disability, death, or retirement. These distributions may
be made in a lump sum or in installments over a period of years. If
employees become disabled or die, they or their beneficiaries receive
the vested portion of their ESOP accounts right away.

Capital Appreciation. Companies
Dilution. If the ESOP is used to
sell some or all of their equity to
finance the companys growth, the
employees and by doing so convert
cash flow benefits must be weighed
corporate and personal taxes into
against the rate of dilution.
tax-free capital appreciation. This
allows the owner to sell 100% of his
committee members who administer
or her company, get money out taxthe plan are deemed to be
free and still maintain control of the
fiduciaries, and can be held liable if
improper transactions.
Provides a cost-effective plan to
Liquidity. If the value of the stock
motivate employees. After all, who
appreciates substantially, the ESOP
works harder, owners or employees?
and/or the company may not have
sufficient funds to repurchase stock,


advantaged purchasing of stock of a

retiring company owner. With this
purpose, a company owner may sell
their shares to the ESOP and incur
no taxable gain on the sale. A
company owner can sell all or some
of the company to the employees cost
free. Owners who sell 30% or more of
their company to an ESOP are
allowed to "roll-over" the proceeds
into other securities and defer
taxation on the gain.
Company reduces it's tax liability.
A company can reduce its corporate
income taxes and increase its cash
flow and net worth by simply issuing
treasury stock or newly issued stock
to its ESOP.

upon employees retirement.

Stock Performance. If the value of
the company does not increase, the
employees may feel that the ESOP is
less attractive than a profit sharing
plan. In an extreme case, if the
company fails, the employees will
lose their benefits to the extent that
the ESOP is not diversified in other

What is the best way to implement ESOP?

1. Determine how you want to use the ESOP. Will it be used as an
employee benefit plan? Or, as an incentive program?
2. Conduct a feasibility study to determine the value of the companys
stock and impact of the contributions that must be made to the
3. An ESOP requires different accounting procedures and a different
method of allocating stocks and other investments among the
employees than other types of plans. For this reason the plan
should be designed by an ESOP specialist in order to avoid IRS
What are the alternatives to ESOP?
1. Employee stock options.

Profit Sharing. An ESOP differs from a profit sharing plan in that

ESOP is required to invest primarily in employer securities, while a
profit sharing plan is usually prohibited from investing primarily in
employer securities.




An Act to regulate the payment of wages to certain classes of employed
An Act to provide for fixing minimum rates of wages in certain
An Act to provide for the payment of equal remuneration to men and
women workers and for the prevention of discrimination, on the ground
of sex, against women in the matter of employment and for matters
connected therewith or incidental thereto.
Act to provide for the payment of bonus to persons employed in certain
establishments on the basis of profits or on the basis of production or
productivity and for matters connected therewith.
An Act to provide for certain benefits to employees in case of sickness,
maternity and employment injury and to make provision for certain other
matters in relation thereto
An Act to provide for the institution of provident funds 2*[3*[, family
pension fund and deposit-linked insurance fund]] for employees in
factories and other establishments
An Act to provide for a Scheme for the payment of gratuity to employees
engaged in factories, mines, oilfields, plantations, ports, railway
companies, shops or other establishments and for matters connected
therewith or incidental thereto
An Act to provide for the payment by certain classes of employers to their
workmen of compensation for injury by accident


Whether extrinsic rewards such as performance-related pay actually
motivate employees to better performance is a matter of controversy. It
has been claimed that monetary rewards usually have a limited timespan in regard to their motivating effect. Therefore extrinsic rewards
such as performance pay, even if they can exert a continuing impact on
performance, should

be consistent with overall management objectives, so that

performance pay may not be consistent with, for example, a purely
cost reduction strategy &

only be used to reinforce a motivational system in which intrinsic

(non monetary) rewards exist, such as reorganization of work
processes, training, employee involvement/consultation in
decision-making, two-way communication, opportunities to
contribute ideas, career development plans and goal setting.

Some of the reasons for the failure of performance-related pay and some
of the problems and issues facing employers flow from a variety of
circumstances such as the following:

Inadequate criteria to measure performance, or criteria which are

not easily understood, communicated and accepted. Performance
pay should therefore be negotiated.


Inappropriate performance appraisal systems in that the objectives

of the appraisal system (e.g. where it is intended to identify
training needs or suitability for promotion) do not match the
objectives of the reward system.


The absence of regular feedback on performance.


The reward system is not designed to meet the objectives sought to

be achieved. There could be a variety of objectives e.g. to satisfy
distributive justice, attract and retain capable staff, match
particular levels of pay in the labour market, change organizational
culture (e.g. towards greater customer satisfaction) or to reinforce


The absence of a right mix of extrinsic and intrinsic rewards.



The lack of an appropriate quantum of pay which should be

subject to performance criteria. This occurs when the amount
which depends on performance is too small, or it is too large and
therefore the amount placed at risk (when performance is poor) is
not acceptable to employees.


The absence of periodic evaluation of the scheme.


Non-recognition of the fact that performance, especially profit, is

sometimes (even often) dependent on factors outside the control of
employees e.g. management decisions, exchange rates, recessions.

There are many arguments in favour of performance-related pay which

are theoretically attractive. However, it is not easy to find evidence which
unequivocally supports or disproves these views, because of the scarcity
of empirical evidence or because the introduction of the scheme has been
faulty. Governments can sometimes facilitate the introduction of
performance-based pay. In Britain for instance, the Finance Act of 1987
introduced tax relief for approved schemes to encourage their adoption
and proliferation.
Two benefits at the macro level have been claimed for performance pay.
The first relates to employment. If increases in basic pay are transferred
to a profit-related scheme (e.g. 10% of basic pay), the employer may be
more inclined to hire new employees as his wage cost is less than
otherwise. If the percentage of profit to be shared remains fixed,
additions to the workforce do not cost the employer more in terms of the
profit-related pay. On the other hand, new recruitment would reduce the
quantum existing employees will receive unless profits increase, and
consequently dissatisfaction among employees could set in.
The second argument is that if basic pay is reduced as a percentage of
total earnings, increased earnings will not result in inflationary
tendencies as such increases are the result of increased
The benefits to management and employees are:

where performance/profits increase, higher pay is an incentive to


where profits reduce, the reduction in the performance-related pay

can cushion employees against redundancies

employee identification with the success of the business is


variations in pay lead to employees becoming more familiar with

the fortunes (or misfortunes) of the business. This would depend
on the information-sharing practices of the management.

Several criticisms of a general nature (apart from those directed at

particular types of schemes) have been made against performancerelated pay. Among them are the following:

where the performance earnings fall employees are less inclined to

accept reductions in their guaranteed pay


positive employment effects could be negated due to opposition

from employees to recruitment as it would dilute their earnings


since performance/profits depend on a variety of factors beyond

the control of employees, it is not possible to link pay to the
performance of employees. If it is linked to the overall performance
of the enterprise, then management decisions should logically be
subject to scrutiny by employees.


it is difficult to determine whether the amounts paid out under

schemes are more than matched by performance gains.

Even though the evidence is not always clear whether profit-sharing, for
instance, raises productivity levels, the positive link between profitsharing and productivity is clearer in enterprises with employee
participation arrangements. Where the extra payments replace a fixed
wage component and is not an additional component of pay, there is a
greater likelihood that the extra pay is matched by performance
increases. In the case of group incentives payments are never
proportionate to individual performance, as poor performers ("free
riders") benefit from the efforts of others.


A. Subsistence Theory
Propounded by David Ricardo, 1817
Also known as the "Iron Law of Wages

Was an alleged law of economics that asserted that real wages in the
long run would tend to the value needed to keep the workers'
population constant
Ricardo drew a distinction between a natural price and a market
price. For Ricardo, the natural price of labor was the cost of
maintaining the laborer. However, Ricardo believed that the market
price of labour or the actual wages paid could exceed subsistence
level indefinitely due to countervailing economic tendencies
Ricardo believed that the market price of labor could long exceed the
subsistence or natural wage
He also claimed that the natural wage was not what was needed to
physically sustain the laborer, but depended on "habits and customs
The labourers are paid to enable them to subsist & perpetuate the
race without increase or diminution
The theory maintains that wages cluster around the bare subsistence
level of workers. A wage rate much above the subsistence level causes
an increase in the number of workers; competition will then lead to a
depression of wages back towards the cost of subsistence. Wages that
are below subsistence reduce the size of the working population; in
that case competition will raise wages, but only up to the subsistence
level again.
* Subsistence means minimum resources required for existence
* Diminution means change toward something smaller or lower
B. Wage Fund Theory
1 Developed by Adam Smith (18Century)
2 The wage-fund theory is that wages are advanced out of a fixed
fund of capital, from which an excess withdrawal, either through
legislation or through union pressure, will ultimately reduce the
amount available for other workers.
3 Any increase in wages would also have to be taken out of profits,
and their reduction would cause a decline in savings, which
provide the capital from which the wage fund is derived.
4 Basic assumption wages are paid out of a pre-determined fund of
wealth which lay surplus with wealthy persons as a result of
savings. This fund could be utilized for employing labourers for
If the fund was large, the wages would be high; if it was
small, the wages would be reduced to the subsistence level
The demand for labour & the wages that could be paid them

were determined by the size of the fund

C Residual Claimant Theory
- Propounded by Francis Walker in 19th Century
- There are 4 factors of any business activity:
Land, Labour, Capital, Entrepreneurship
Wages represent the amount of value created in the
production which remains after payment has been made for
all these factors of production, thus implying that
The labour is the residual claimant
- After all the factors of production have received their
for their contribution to the process, only then the
labourers wages come to the fore
Theory does not explain how trade unions are able to
increase the wages
No role of labourers in productivity
D Marxian Theory
- In the surplus-value theory as propounded by Karl Marx, the value
produced by the worker in excess of what is paid in wages is called
surplus value
- The surplus value, exacted from the worker, constitutes the capitalist's
- According to this theory, labour was an article of commerce could be
purchased on payment of subsistence price
The price of any product was determined by the labour time
needed for producing it
The labourer was not paid in proportion to the time spent
on work, but much less
The surplus went over, to be utilized for paying other

A. Marginal Productivity Theory
- Developed by Philips Wicksteed & John Bates
The wages are based upon an entrepreneurs estimate of the value that
will probably be produced by the last of marginal worker
It assumes that the wages depend on the demand for, and supply of
Workers are paid what they are economically worth
The employer has a larger share in profit as has not to pay for the



non-marginal workers
As long as each additional worker contributes more to the total value
than the cost in wages, it pays the employer to continue hiring
When this process becomes non-viable & uneconomic, the employer
may resort to superior technology
- This theory maintains that employers will only pay a wage that is,
at most, equal to the amount of extra value added to the total
product by one additional worker
Bargaining Theory
- Propounded by John Davidson
- Wages are determined by the relative bargaining power of the
workers / trade unions & of employers
- When a trade union is involved, basic wages, fringe benefits, job
differentials, and individual differences tend to be determined by
the relative strength of the organization & the trade union
- The bargaining theory modifies the marginal-productivity theory
Taking into consideration other factors (e.g., laws and social
and political changes) that might affect the determination of
wage levels
Acknowledging that certain basic assumptions (equal
bargaining power of employer and employee, free competition
between the two, and mobility of labor) that characterize the
marginal-productivity theory do not hold in our present
economic system
Supply & Demand Theory
- Inter-relation between wages & employment
- Unemployment were to disappear if workers were to accept a
voluntary cut in wages have wage flexibility for promoting
employment at a time of depression.
- These wage cuts would bring down costs and thereby fall in
- This lowering in prices would cause additional demand which
will increase production
- This will increase employment of workers

D. Competitive Theory
- Employers compete amongst themselves by offering a higher pay
/ wage to attract employees while employees compete with
another for jobs by offering their services for a lower wage

Competition then, is essentially a disequilibrium process by

which excess demand and excess supply cause changes in

Behavioral Theories
Employees acceptance Level
- This theory takes into consideration, the factors which may induce an
employee to stay on with the company
Size & reputation of the company
Power of the union
Wages and benefits that the employee receives in proportion
to the contribution made by him / her
B. Internal Wage Structure
- Wage Structure affected by
Social norms / traditions / customs prevalent in the
Psychological pressures on the management
Prestige attached to certain jobs in terms of social status
The need to maintain internal consistency in wages at all
The ratio of maximum & minimum wage differentials
Norms of span of control
Demand for specialized labour
C. Wage & Motivators
- Purchasing power provided by monitory income helps workers to
take care of their basic needs:
Food / Clothing / Shelter / Transportation / Insurance /
Pension Plans / Education / Other physical maintenance &
security factors
- Monitory income includes:
Wages / Merit increases / performance based bonuses
Advent of the Labour Force
During the period of foreign rule, Britishers introduced industrialization
and thereby heralded the advent of labour sector in this country. With
the emergence of native industrialists the labour sector expanded. The
pace of industrialization and the expansion of labour sector were
accelerated by the first and second world wars.

In the early years the workers organized to obtain wages to meet

limited needs for livelihood and convenience to work decently. Labour
struggle became a part of national movement. The concepts of
freedom, democracy, secularism and socialism, were indoctrinated in
the labour movement, thanks to agitations for rights of workers.
The trade union leaders of yesteryears played a glorious role in
this respect. We are still striving to ensure social security measures
envisaged in the directive principles of the Indian Constitution such
as right to work, living wages, security in work place etc.
Today the economy of the nation itself is facing grave crisis due
to the impact of globalization, and the labour sector is in the dark
shadows of economic and social problems. The threats faced by the
economy of the nation, industry, agriculture and thereby the labour
sector are due to the impact of the global pressures and hence beyond
our control. Yet we are compelled to defend ourselves to protect our
economic and social security
Consequent on the grave crisis in the Indian economy,
significant reforms based on liberalization, globalization was enforced
from 1991. It was these economic reforms that dictated the industrial
policy from then on. Only after a couple of years of reforms that
negative effects on other sectors of polity came to be felt, the most
affected being the Labour

Need of the Hour

Ensuring equity as well as accelerating the rate of growth of

economy in the labour market is the need of the hour
It is necessary to ensure significant improvements in the quality of
labour, productivity, skill development and working conditions, and to
provide welfare and social security measures particularly, to those in
the unorganized sector
It is also necessary to ensure that all adult persons looking for work
are employed at levels of productivity and income, which are
necessary to afford them a decent life. A significant proportion of
workers presently earn below the subsistence wages
Another unfortunate facet of labour markets is the persistence of child
labour which must be eradicated in the shortest possible time

Modern day professions as we know them had their origin in the

post-industrial age after World War II when most Western nations saw

a long spell of growth

This era also saw the emergence of modern day consumerism. To

cater to the emerging needs of the market, huge corporations built
gigantic factories to manufacture products and serve the needs of

They also started employing thousands of people to

manufacture, service and market the products

Sometime during this period (in 1956), William H Whyte wrote his
much acclaimed book titled the Organization Mana term which
caught the fancy of an entire generation of working professionals. For
Whyte Organization Men are People who only work for the
Organization. They are the ones of our middleclass who have left
home, spiritually as well as physically, to take the vows of organization
life, and it is they who are the mind and soul of our great selfperpetuating institutions

For nearly half century after the book appeared, Organization Man
typified the working class. In most parts of the world, huge
corporationsprivate, public and government-ownedemployed
hundreds of thousands of Organization Men

In the US, Fortune 500 companies created millions of jobs.

Similarly, UK, Europe, the Eastern bloc, and India saw the emergence
of huge government owned corporations and Public Sector
Undertakings (PSUs) that employed millions

In many parts of the world, government service was the career

choice for a generation of the best and the brightest. In India, joining
the Indian Administrative Service (IAS) or Police Service (IPS) was the

In the US, President Kennedys "send a man to the moon" project

captured the imagination of a whole generation of youngsters who
either wanted to become rocket scientists or astronauts for NASA

A whole generation of the best and brightest from top universities

competed to give their life and souls, and dedicate their professional
lives to mammoth corporations by joining the burgeoning ranks of
Organization Men. In return, they were assured of a steady paycheck,
raises, promotions and a golden watch at retirement, with a
guaranteed pension to boot

Educated professionals were not the only ones welcomed by these

There was a need for everyonefrom the mailroom clerk and janitor to
shop floor workers, supervisors and managers; and everyone else in

One common aspect binding all employees was their unrelenting
loyalty to the organization. There was very little individualism and
entrepreneurship shown (or expected) by employees, and most of the
decision-making took place in ivory towers at head offices
The organizations asked for, and got the unwavering following of its
organization men; in return, it guaranteed employment, almost taking
on a patriarchal role for families of organization men
There is little debate over the fact that we are experiencing a major
shift in the job market worldwide
Changes in the marketplace are leading to a fundamental shift in
careers and professions across the board
Perhaps the most important shift in the paradigm is the move from
Organization Man to Free Agents or Gold Collar Workers
Individuals will not remain loyal to one single organization,
just as most organizations have given up on guaranteeing
lifetime employment
New entrants to the job-market, and even those who have
been working in the corporate world for a while are starting
to realize that we cannot hope to become, or remain,
Organization Men
The New Generation

This workforce contains the now generation, me

generation, new breed, and new X generation

These generations have been variously described as

having lower overall job satisfaction, less desire to lead (move up the
organizational hierarchy) and to defer to authority; believe that they
are entitled to a good job; have a strong a desire to control their own
destiny; have a low absenteeism threshold

They have also been described as having a lower

respect for authority, and a greater desire for self-expression, personal
growth, and self-fulfillment

This group also tends to be more educated than

their predecessors, in most cases, they are more educated than their

Impatience and self-confidence define today's

educated young worker

In older times, people used to do anything to get a

job - Today everyone thinks they're entitled to a job
In the old days, such attitudes were unimaginable; they
would have been self-defeating
Companies are no longer in the driver's seat - Employees are
in control now

Labor Market Discrimination

What is Discrimination?

The valuation in the market place of personal

characteristics of the worker that are unrelated to worker productivity.
These personal characteristics may be sex, race, age,
national origin, religion, education or sexual preference

Labor market discrimination may take the form of

different wage rates for equally productive workers with different
personal characteristics

Labor market discrimination may also take the form of

exclusion from jobs on the grounds of social class, union
membership, or political beliefs
Labor Market Discrimination

Discrimination is a cause of labour market failure and

a source of inequity in the distribution of income and wealth and it is
usually subject to government intervention e.g. through regulation
and legislation

Discriminatory treatment of minority groups leads to

lower wages and reduced employment opportunities, including less
training and fewer promotions. The result is that groups subject to
discrimination earn less than they would and suffer a fall in relative
living standards
Why does discrimination occur in the labour market?

The 'Taste' Model - Discrimination arises here

because employers and workers have distaste for working with people
from different ethnic backgrounds or final customers dislike buying
goods from salespeople from different races i.e. people prefer to
associate with others from their own group. They are willing to pay a
price to avoid contact with other groups. With reference to race, this is
equivalent to racial prejudice

Employer ignorance Discrimination also arises

because employers are unable to directly observe the productive
ability of individuals and therefore easily observable characteristics
such as gender or race may be used as proxies the employer through
ignorance or prejudice assumes that certain groups of workers are
less productive than others and is therefore less willing to employ
them, or pay them a wage or salary that fairly reflects their
productivity, experience and applicability for a particular job

Occupational crowding effects Females and

minorities may be crowded into lower paying occupations. There is
little doubt that a permanent gap exists between average pay rates for
females and males in the labour markets of UK, US, Africa, Europe &

Quality in Labour Market

Towards Productive Employment

Country like India has tremendous labor cost

advantage as far as daily or monthly wage rates are concerned. But
there are limitations due to poor quality of training and skills, nonprofessional approach, low productivity and too many labor laws.

The labor market is deregulated & there is increased

mobility of labor in global markets

Many other low cost countries like china, Mexico,

Turkey, SAARC region neighbors, some north African and Latin
American countries are moving fast on learning curve and will offer
tough competition to Indian exporters in low cost labor advantage

The real labor cost will rise in countries like India

erasing much of low cost advantage of labor

Labour market demands are changing with greater

emphasis on the quality of jobs

Labour market reforms are necessary to cope with the

accelerating economic and social restructuring associated with
globalization, technological processes and the development of an
inclusive knowledge and information society and economy

In an era of globalization where capital, technology,

high skills and high productivity play a major role in labour markets

In India, like in many other developing countries, the

growth of labour force is accelerating and will remain high for quite

It needs rapid economic growth with effective and

efficient utilization of labour by upgrading its skills to ensure
development and employment generation.
Intervention is required in labour markets to promote
employment and its quality.
Quality in work including training, career prospects
and work organization makes a valuable contribution towards
increasing employment and productivity
Improvements in the quality of work may increase the
efficiency of production processes by allowing employers to exploit
fully the potential of new technologies
They are further likely to increase employees
motivation and job satisfaction
Upgrading the quality of labour force by pursuing
suitable education and skill development policies
Low quality of jobs and low productivity is directly
attributable to low level of skills. The latter poses a serious challenge
to integration of the labour force in world economy
There is overwhelming evidence that whereas educated
and skilled workers are generally able to derive some benefits of new
opportunities as a result of globalization, it is the uneducated and
unskilled workers on whom the burden of re-structuring falls
Designing appropriate training systems is, therefore,
an important means to deal with labour market instabilities like
under-employment, skill mismatch and redundancy
Higher productivity of labour would, apart from dignity
of labour, improve the living standards of workers and also help the
industry in facing international competition
An increase in overall productivity and skill upgradation will lead to progressive absorption of large number of
workers from informal or unorganized sector in the formal or
organized sector and ensure rapid economic growth
Quality of labour force alone determines their
employability abroad or in institutions of foreign origin including
multinational organization
Manpower development to provide rising labour force
with skills and training according to the emerging demand pattern is
essential to eliminate the mismatch between the supply of and
demand for labour


Reward Management in TNCs (Transnational Corporations)
Transnational Corporations

Transnational Corporation means a for-profit enterprise marked by two

basic characteristics:
It engages in enough business activities -- including sales,
development -- outside the country of origin so that it is dependent
financially on operations in two or more countries

Its management decisions are made based on regional or

global alternatives

In an era of declining constraints on their mobility and the

attraction of cheaper wages in less-industrialized nations eager to
draw foreign investment, TNCs are eliminating jobs in their home
countries and shifting production abroad

In less-industrialized regions, the lure for TNCs of fewer

costs and regulations offers little promise to workers of decent
working conditions, sufficient pay, or job security.

Tax breaks and subsidies governments use as incentives are

no guarantee that the TNCs will not move on after the benefits have
expired, and as cost advantages now found in Singapore appear in,
say, Bangladesh, the countries currently experiencing an influx of
investment may eventually find themselves in the same position as
that of the US and other industrialized nations today.

TNCs are corporations that operate in more than one

country. Usually, headquarters are in one or more nations and
production or services are in another have become some of the most
powerful economic and political entities in the world today.

Such companies have a geocentric orientation and attempt to

be responsive to both national markets, while simultaneously seeking
global coordination

The number of transnational corporations in the world has

jumped from 7,000 in 1970 to 40,000 in 1995
What is the difference between Multi National Corporation and Trans
National Corporation?
MNCs operate in several different countries while transnational
implies "just across the border" as in the US and Canada. Obviously,
both operate internationally

A MNC has a centralized headquarters & is a corporation with

extensive ties in international operations in more than one foreign
country. Examples are Coke, Pepsi, General Electric, Exxon, WalMart, Mitsubishi, Diamler Chrysler
A transnational company has no "head office" and moves whatever
base of operations it has fluidly between its national offices. It is a
MNC that operates worldwide without being identified with a national
home base i.e. it is said to operate on a borderless basis. Examples
are Daewoo, Saint Gobain, Daimler-Benz, Sony, Samsung Group,
Shell Oil etc

Reward Management
- The type and amount of compensation necessary to attract technically
and culturally qualified international managers and technical
professionals to the three nationals or country categories involved
international human resource management activities from which
employees are selected whether the people are:
PCNs (parent country nationals)
TCNs (third country nationals) or
HCNs (host country nationals)
HR managers focus on their strategic objectives to develop a
comprehensive compensation plan, in terms of considering base pay,
short and long-term incentives, benefits and growth opportunities
The objective of this kind of strategy is to ensure that both
TNC/MNCs long and short-term objectives coexist in the
compensation system without overlap, which would duplicate a single
pay plan for the same objectives.
The purpose of the planning is also designed to ensure that the
compensation system attracts and retains the desired employees and
that it motivates them to do those things that support the business
The type and amount of compensation necessary to attract
technically and culturally qualified international managers and
technical professionals to the three nationals or country categories
involved international human resource management activities from
which employees are selected whether the people are:
PCNs (parent country nationals)
TCNs (third country nationals) or
HCNs (host country nationals)
HR managers focus on their strategic objectives to develop a

comprehensive compensation plan, in terms of considering base pay,

short and long-term incentives, benefits and growth opportunities
The objective of this kind of strategy is to ensure that both
TNC/MNCs long and short-term objectives coexist in the
compensation system without overlap, which would duplicate a single
pay plan for the same objectives.
The purpose of the planning is also designed to ensure that the
compensation system attracts and retains the desired employees and
that it motivates them to do those things that support the business
Global Staffers
An expatriate is an employee working in a country other than their
country of origin. An expatriate may also be referred to as a PCN or
parent-country national
PCNs (Parent Country Nationals)
Those personnel who are of the same nationality as the contracting
government or personnel from headquarters
They come from the home country of the operation.
The policy of using PCNs is usually employed when one or more of the
following situations exists: (1) the host country cannot readily supply
desired managerial personnel, (2) efficient communication with
headquarters is required, and (3) the company adopts a centralized
approach to globalization
- TCNs (Third Country Nationals)
Those personnel of a separate nationality to both the contracting
government and the area of operations i.e. whose nation of residence
is neither the host country nor the home country
Such an employee normally is recruited from outside the host
country and
relocated from the point of recruitment to the host country
HCNs (Host Country Nationals)
These are Indigs (Indigenous Personnel) / Nationals / Locals those
personnel who are indigenous to the area of operations
Whose basic residence or home is the host nation
Local colleagues of the expatriate, they are valuable socializing agents,
sources of social support, assistance, and friendship to expatriates.
Expatriates are more likely to adjust when HCNs engage in this
Reward Management

The vehicle for going global is often an

international strategic alliance creating a world of stateless
corporations - a collaboration between two or more TNC/MNCs that
allows them to jointly pursue a common goal

TNC/MNCs are staffed either by recruiting

expatriates from the regular organizations or by creating an
international cadre of managers, professionals, and workers of very
diverse cultural backgrounds

Companies like Gillette, Sony are already doing

their own international cadre of managers now
Recruiting people directly to an international career will assure a
supply of employees who expect and want to go overseas
Consistency within the growth of international business operations
will require effective international human resource management
(IHRM) Involves moving people around the world
Helps HR Managers to formulate and implement policies and
activities in the home-office headquarters
HR Managers responsibilities include selecting, training, and
transferring PCN abroad, and formulating policies for the firm as a
whole and for its foreign operations
In staffing international operations, HR managers face a confusing
array of choices in recruiting and selecting from one of three types of
employees of an international firm. The three nationals or country
categories involved in international HRM activities are:
The host-country where the subsidiary may be located
The home country where the firm is headquartered
Other countries that may be the source of labor or finance
For example, P&G employs Eritrean citizens (HCNs) in its Eritrean
operations, often sends U.S. citizens (PCNs) to the Gulf countries on
assignment, and may send some of its Italian employees on
assignment to its Mexican operations (as TCNs)
These three types of employee groups have very different cultural
backgrounds. Therefore, TNC/MNCs HR managers must coordinate
policies and procedures to manage from the firms home country as
well as in subsidiaries around the world in shaping international
compensation and reward systems.
These policies and practices must effectively balance the needs and
desires of HCNs, PCNs and TCNs as well - Failure to recognize
differences in managing human resources in international


environment frequently results in major difficulties in international

Managing of a global workforce can be an important factor in the success
or failure of an TNC/MNC:
TNC/MNCs HR managers must staff their international business
operations with personnel who are technically competent, culturally
proficient, and cost-effective. In almost all cases, it is generally argued
that it is cheaper to employ HCNs than to send expatriates (PCNs or
TCNs). TNC/MNCs may find expatriates too expensive to employ in large
The International Compensation Challenge
Compensation is one of the most complex areas of international
human resource management
Pay systems must conform to local laws and customs for employee
compensation while also fitting into global MNC policies
Managers face diverse political systems, laws & regulations, confront
different economic climates, economic development, tax policies,
diverse culture, customs, the role of labor unions, standard of living
For example, union influences may play an important role in
determining wage policies in some countries such as Australia
where the Australian Government and unions negotiate pay rates
for workers that apply nationwide.
In Hong Kong, by contrast, labor unions are extremely weak, and
wage rates are determined by the free market
All these different factors between international communities affect
international compensation systems. Therefore, finding the right
method for TNC/MNCs to determine a compensation package in an
international market is simply becoming a nightmare
It is also important for MNCs to consider carefully the motivational
use of incentives and rewards among the employees drawn from three
national or country categories
The traditional function of pay to attract, retain and motivate
employees has not changed - The emphasis has shifted from the
attraction and retention functions to the motivation function.
TNC/MNCs must ensure that those skilled employees are
compensated for achieving goals that make the international business
operations succeed
As different countries have different norms for employee
compensation, HR managers should consider carefully the

motivational use of incentives and rewards among international

For Americans money is likely to be the driving force even though
no financial incentives such as prestige, independence, and
influence may be motivators
Other cultures are more likely to emphasize respect, family, job
security, a satisfying personal life, social acceptance, advancement,
or power
Since there are many alternatives to money, the rule is to match the
reward with the values of the culture
There are wide variations both between countries and among
organizations within countries concerning how to compensate workers
The principal problem is salary levels for the same job and the jobs
are different between countries in which an TNC/MNC operates
Compensation policies can create conflict if local nationals compare
their pay packages to the expatriates and conclude that they are
being treated unfairly
Can create resentment and envy on the part of HCN managers and
lower their morale and productivity

Unique Compensation Issues in International Scenario

Incentives provided to stimulate movement or expatriation to
a foreign location / host country
Allowances for repatriation to home country
Additional tax burdens placed on employees working in a
foreign location
Labour regulations in home and host country
Cost-of-living allowances in the host country
Home country and host country currency fluctuation
Formal and informal compensation practices unique to the
host country
Determining home country for setting base pay of TCNs
Compensation Strategy for Global Staffers
A successful compensation strategy involves keeping expatriates
motivated while meeting TNC/MNC goals and budgets. TNC/MNCs
HR managers must build an expatriate pay package by:
Meeting corporate goals at home and abroad
Keeping expatriates motivated
Complying with company budgets

This strategic perspective on the linkage between IHRM and strategy

is so critical for a TNC/MNCs success. A TNC/MNC that can develop
a highly trained, flexible, and motivated international workforce is at
an advantage relative to its competitors, especially if that workforce
can be used strategically to support corporate goals. It is essential
that there is synergy among business objectives, staffing, and
compensation. A sound expatriate strategy is a key to international
business success and should be a major interest of senior

Management challenges





HR managers focus on their strategic objectives to

develop a comprehensive compensation plan, in terms of considering
base pay, short and long-term incentives, benefits and growth

The objective of this kind of strategy is to ensure that

both TNC/MNCs long and short-term objectives coexist in the
compensation system without overlap, which would duplicate a single
pay plan for the same objectives.

The purpose of the planning is also designed to ensure

that the compensation system attracts and retains the desired
employees and that it motivates them to do those things that support
the business plan

The compensation costs of a family with children are

shifted to hardship allowance for schooling, childcare, increased
residence cost and all fringe benefits associated with supporting a
family life cycle

Designing the Compensation Program

Balance business objectives with the compensation
programs such as base salary, taxes, allowances, cost-of-living
allowances (COLAs), housing and reimbursable expenses.

The levels of salary and types of fringe benefits paid

to the three primary labor pools of international managers are well
documented. What has not received adequate attention is the
difference among PCNs, HCNs, and TCNs.
For example, executives, middle managers and supervisors who are


expatriate managers in international assignments, receive a variety of

package of benefits
In addition to salary, taxes and benefits, international managers also
receive different allowances as part of their overall compensation to
accept an overseas position
The most noticeable differences among the three labor pools of
international managers are
Overseas premiums
The foreign service premium is based on the expatriates level in
the company, the family size, and the location
Another type of premium is the hardship allowance and home
leaves. The U.S. Department of State established a hardship list in
1996 to help organizations providing expatriate managers hardship
allowances as a percentage of their base salary
Housing allowances
Entails substantial additional costs
TNC/MNCs differ in policies regarding employee contributions to
Cost-of-living allowances
Provided to help PCN or TCN enjoy a standard of living abroad that
is comparable to what they would enjoy in the home country
Tax equalization
PCNs pay no more income tax and no less than if he or she stayed
Repatriation allowances
Paid on return of employee to his/her country of origin to live there
Performance-based bonuses

Additional Payments and services

Lifestyle enhancement services

Provision for employee & family to learn the local language
Education & training of employee & family on local culture, customs
and social expectations
Counseling services for employee & family
Assistance in finding a home at the foreign work site / school &
suitable education programmes for children & dependents
Company car, driver, domestic staff, child care
Use of Fitness facilities / subsidized health care services

Assistance in finding suitable & acceptable employment for spouse

Assistance in joining local civic, social, professional organizations
Allowances & Premiums
Foreign service premium & tax equalization allowance
Temporary living allowance
Hardship premium
Currency protection
Mobility premium
Home-leave allowance
Stopover allowance
Completion of assignment bonus
Assignment extension bonus
Emergency loan
Extended work-week payment

The Expatriate Compensation Balance Sheet: Summary

Expatriate (PCN or TCN) compensation programs are an important
issue in managing reward systems. Compensation plans for expatriate
managers must be:
Competitive, cost effective, motivating, fair and easy to understand,
consistent with international financial management, easy to administer,
and simple to communicate

UNIT III: CEO Compensation - Compensation of Chief

Executives & other employees
Some quotes

CEOs should be compensated 15 times more than the lowest-paid

salary of an employee in a company. I am against mandating a ratio,
but it can be anything from 15 to 25 times the lowest salary.
-Infosys' Narayana Murthy at CII's leadership conference on the

issue of high CEO compensation.

"The excessive flab on CEO emoluments should be cut.

- Anu Aga, Chairman, Thermax.

"CEOs 25 years ago never got a million dollars; their compensation

was based on common sense. Back then, CEOs were seen as diligent
managers who had skill motivating people and just got promoted up
through the ranks."
- Robert Stobaugh, Professor Emeritus, Harvard Business School.
Current Compensation Packages
Annual pay*
(Rs crore)


Co's sales Co's profit


Sunil Bharti Mittal

CMD, Bharti Airtel





Pawan Kant Munjal

MD, Hero Honda





Rajiv Bajaj

MD, Bajaj Auto
EVP and MD, Jindal







MD, Tata Steel















Malvinder Mohan Singh CEO, Ranbaxy





Azim Premji





Naveen Jindal
B Muthuraman
K V Kamath
Aditya Puri
Pankaj R Patel


CMD, Cadila
CMD, Wipro

Gajendra Patni
ED, Patni Computer 2
Notes: The payments are according to the 2005-06 annual report; The sales and profit growth
figures are for 2006-07

Compensation Comparison

USA is a market leader in top managerial compensation

CEO and top managerial salaries in India have climbed but are
puny in comparison to the global standards

Both globally and nationally, CEO pay has increased way ahead of
sales and other employee wages

Both globally and nationally, Corporate performance not kept pace

with CEO pay increase
Historical Perspective: in India

In 1980s, restrictions on managerial compensation

resulted in complete erosion of earnings at senior and middle levels
(Companies Act 1956)
Resulted in Chief Executives looking for better options
In 1988 restrictions on directors salaries were raised
to INR 15,000/-pm under Section 269, Companies Act, 1956,
Schedule XIII
In 1993, revision of Schedule XIII by the Government.
Directors Salary limit raised to INR 50,000/- pm plus commission
equal to annual salary
Perks could be drawn equal to annual salary or INR
4,50,000/- pa whichever was less
Overall limit of INR 10,50,000/- pm including perquisites
was kept
1990s was a tumultuous period for Executive
Salaries were low, stable and predictable
Legal ceilings existed on remuneration (salary and
commissions) of directors
Ceilings designed keeping in mind government officials Bureaucratic structure- relationship with performance of business
was non-existent
Post liberalization and globalization, the trend reversed
Mega bucks for the chief executives from 1991
Demand for competent, talented grew but supply did not
MNCs recruited high quality manpower or their global
operations at comparatively lower rates
Indian family owned companies had to match the
remuneration offered by MNCs
Complex compensation structure (allowances, benefits
included) against high tax structure
Wide differences industry wise in salary levels due to
demand and supply trends, profitability, growth rate etc
1980s was boom period for advertising
Early 1990s for financial services
Late 1990s petrochemical, IT, power, insurance

2000 IT and telecom, biotechnology

Revision of salaries for government officials in 1996 &

PSU employees in 1997 had a spiraling effect

The % increase in chief executive salaries was not the

same as those of the junior level employees

Present Compensation trends

IT is highest pay master strategy for employee

retention especially of employees with skill sets not easily available

Annual increments not related to tenure but only to


Compensation structure still not appreciated in

terms of employee satisfaction and real cost

Salary increases reduced from 2000 in all sectors

Entry-level MBAs & engineers packages has come


Highest compensation sectors are:

Components CEO Compensation

Base Salary

Short-term performance bonuses

Variety of Equity (stock ownership) related


Severance packages (golden parachutes)

Retirement plans

Wide variety of benefits and perquisites

Benefits and perquisites include:

Company-provided car
- Medical expense reimbursement
- College tuition reimbursement for
Chauffeured limousine
Kidnap and ransom protection

Counseling service (financial & legal services)

Attending professional conferences & meetings
Spouse travel
Use of company plane and yacht
Home entertainment allowance
Special living accommodations
Club membership
Special dining rooms
Season tickets to entertainment events
Special relocation allowance
Use of company credit card
No and low-interest rate loans

Features of Executive Compensation

Performance criteria must have approval of

shareholders, directors outside the compensation committee, be
formula driven
Should not be compared to wage & salary schemes
of the other employees
Chief Executives are not as organized as Unionized
A level of secrecy needs to be maintained
Remuneration depends on competence, experience,
length of service, loyalty to founders, excelling areas like M&A
specialist, turnaround specialist etc
Not based on individual performance but rather on
organizational performance
Subject to statutory ceilings especially in the public
sector Ceilings do not apply private sector
Supposed to be guided by job evaluations, JDs,
salary grades with ranges of pay in each grade & salary survey but
exorbitant in reality

Problems of Executive Compensation


Enormous differences between the pay, income and

wealth of the front-line and the top executives opposed heavily this

Increases in compensation received by Chief

Executives are far out of line with those provided to the rest of the

While CEO received almost 36% raise, workers received only

3.9% raise in some cases

This exorbitant CEO compensation is a direct cause of

the rise in union membership

Leads to demoralizing other employees

Unfair to shareholders

Can even lead to distorted behavior

CEO Compensation
The high compensation to CEOs had been a debatable issue over
the years among corporates as well as the investors all over the world.
Market analysts and stakeholders had criticized companies for paying
exorbitant compensations to CEOs and argued that this would widen
the gap between the top level and other levels of management.
By early 2001, paying high compensation to CEOs became a very
controversial issue due to the global economic slump and poor
performance of corporates. The issue was strongly debated not only in
the US, but also in countries including UK, South Korea and India.
- The shareholders were not happy with the fact that CEOs' salaries
continued to rise in spite of the poor performance of the stocks. They
argued that, though the compensation of the CEO was linked to the
company's performance, there were instances where, in spite of the
poor performance of the company, the CEO concerned got a decent
hike in compensation package.
Guidelines for CEO Compensation
Corporate Governance
A corporate governance aspect to CEO-pay
- Revolves around the decision process involved in fixing a CEO's
compensation; In some, corporate HQ lays down the broad
guidelines while the actual compensation is a function of local
market conditions

In the Indian context it is the board of directors that decides the

compensation of CEOs
Since most CEOs also chair the board, this means they write their
own pay-cheques. However, some companies (especially the
progressive ones) have compensation committees in place

Corporate Governance: What the ideal situation should be

At a theoretical level, compensation committees are a must in
companies that weave performance-based and stock-based variables
into the overall salary.
With an increasing number of companies moving to such
compensation structures, committees, logic dictates, should become
the norm.
More important, regulations may soon insist on external
representation on these committees.
Companys Act 1956
In India the Companies Act is the legislation that primarily
shapes the remuneration of top managerial personnel.
Until 1993, the Act provided for an upper limit in the amount of
compensation to be paid.
It had been pointed out that the "regulation of director's
remuneration becomes necessary for several reasons, prominent
among them being the prevention of diversion of corporate funds for
personal use and the impact which an unduly high executive reward
has upon the rest of society."
However, over the years, with the shift in India's economic
policy towards a market-oriented capitalistic economy, this particular
legislation has been amended to increase the maximum pay package
limits that are payable to the managerial personnel. While other
reforms have taken their time to be incorporated in to the Act, the
maximum pay ceiling for CEOs has been increased systematically and
more frequently.
One of the main reasons put forward for this regular increase
has been the need to attract and retain talent at the senior level.
Additionally, it has been argued that the risk and responsibility
at the senior level needs to be compensated by a sufficient increase in
the pay packet. Needless to mention the risk and responsibilities at
the CEO's level pertain to the uncertainty associated in fulfilling
organizational objectives. This automatically indicates a strong

relationship between the CEO's compensation and organizational

Logically the CEO's job should be at stake if the organizational
objectives are not fulfilled.
Indian law does not require that the compensation committee
have a charter. The scope of the Companys remuneration committee
includes determination of the Boards compensation and the
Companys policy on specific remuneration packages for executive
directors including pension rights and any other compensation

Managerial remuneration & Companies Act 1956

- The Companies Act, 1956, contemplates five categories of managerial
- a) An ordinary director, who is the director simplicities; b) a part-time
paid director, being a director in the part-time employment of the
company; - a whole-time director, being a director in the whole-time
employment of the company; d) a managing director, being a director
entrusted with substantial powers of management; and e) the manager,
having the management of the whole, or substantially the whole, of the
affairs of the company.
- The remuneration payable to a director may take any one or more of the
following forms: Sitting fee for each meeting of the Board, or a committee
thereof, attended by him; monthly, quarterly or annual payments made
to him; or a commission payable to him at specified percentages of the
net profits of the company computed in the manner referred to in Section
- Thus, the Companies Act enlarges the ordinary meaning to the word
`remuneration' to payment in money or otherwise for services rendered.
- A CEO may be paid remuneration by way of a monthly payment and/or
at a specified percentage of the company's net profits.
- While, some companies prefer not to pay any commission and in lieu
thereof absorb the element of commission into the monthly salary so as
to ensure a steady income for the CEO irrespective of fluctuations in the
net profits of the company from year to year, others go to the extent of
linking the CEO's pay with the share price of the firm by issuing
employee stock options to him/her.
- Consider the remuneration paid to Corporate CEOs (that is, Managing
Directors or Chairman in some organizations). Section 198 of the

Companies Act, 1956, limits the overall maximum managerial

remuneration payable by a public company to persons entrusted with
managerial functions to 11 per cent of the company's net profits
(percentage of the net profits as contemplated by Section 198 (1) is to be
computed in the manner laid down in Sections 349, 350 and 351 in the
Companies Act).
- This percentage is exclusive of fees payable to directors for attending
meetings of the Board or committees thereof. The Section is concerned
especially with managerial remuneration payable to managing directors.
On the other hand, Section 309 is concerned with total remuneration
payable to directors; whatever is the nature of such remuneration,
managerial or otherwise.
- Obliging to the frequent demands/representations of the different
industry chambers and with the shifting economic policy, the Companies
Act was amended from time to time. For example, from a salary limit of
Rs 90,000 pa in 1969-74, in 1994, the upper limit for salary was
eliminated (the only limiting factor being Section 198).
- The Guidelines should have logically helped corporations in
substantially raising their managerial remuneration packages.
- It should have also helped remove the stigma attached in paying large
- However, despite these positive incentives regarding pay packages, one
could question its impact on corporate performance - Did such
phenomenal increases in the limits of managerial remuneration help
raise the performance of organizations?
- Were the increases in these limits made to cope up with the pressures
of competition and globalization, or was there something more to it?

Companies should have completely independent compensation

committees that decide CEO pay
In the absence of such committees, there should at least be a
special sub-committee that decides CEO pay
Whichever form the committee takes, CEO pay should always be
aligned with the performance of the company's stock
The usage of more sophisticated measures of financial
performance, like Total Shareholder Returns (TSR) or Economic Value
Added (EVA)
To use a balanced measurement matrix that includes non-financial

parameters like customer satisfaction and employee engagement

Some companies could even split the variable pay component into
two parts
One of these is related to a company's performance in the shortterm (typically sales and profits)
Another to its performance in the long-term (Market Value Added
or Market Capitalization). The short-term bonus is typically capped
as a percentage of the CEO's salary, while the long-term reward
takes the form of stock options.

New trends expected

- Changes expected Sign-on bonuses
Golden parachutes
Severance packages, all mechanisms that insure CEOs from
uncertainties prevalent in today's job market will become
more prevalent
Additional stock option grants



-The analysis, measurement, control and redesign of a set of activities
performed on ongoing jobs
-A detailed and systematic study of jobs to know the nature &
characteristics of people to be employed for each job
-Involves identification and description of what is happening on the job
It is a labor intensive, time consuming job
Demands a greater understanding of human behaviors, job
requirements, writing skills
Differentiate compensation provided to employees on basis of job
content, job specifications, working conditions, employee job
performance wrt the required tasks, the knowledge and skills
required to perform them, and the conditions under which they
must be performed
Helps in establishing a sound compensation system, using criteria
that measures and differentiates job & performance requirements
so that all employees receive fair and just treatment
- It is conducted in the following situations Employees or union reps demand change in JDs and assignments
of jobs to pay grades, or
Development of a classification system that reflects more

accurately the work they perform, or

Reallocation of job activities at the time of organizational
restructuring, or
Redesigning of the organization & its jobs
- Preliminary considerations for undertaking this costly operation Senior Management support
Workforce Cooperation & Involvement
All employees must understand the responsibilities and duties of
their jobs
Employees and supervisors must be in agreement to these
responsibilities and duties
All employees must receive fair rewards for the knowledge
necessary to solve work-related problems, make decisions and
accept other responsibilities to perform their jobs successfully
- Steps for conducting this process
Schedule the necessary and logical work steps
Developing budget & forecasting financial requirements
Determine the organizational use of job content and other
related data
Learn about the structure, operations, jobs of the organization
org. chart, process chart, procedure manuals
Identify and select methods for collecting job content data and
other related facts
through interview, questionnaire, observation, diary/log, or
combination of any of these
Uses of Job Analysis
Organization design and staffing
Performance review
Safety and health
Affirmative action planning during organizational design &
job design
Employee counseling
Hiring the handicapped
The analysis of the job Activity / task / function / element / duty / responsibility /
behavior / essential job function / competency

- Statements of fact that describe the job
- An organized factual statement of job contents in the form of duties
& responsibilities of a specific job
- Emphasizes the job requirements
- Contents include
Job identification - Job title, location, supervisor, grade, pay
range, plant/division & department/section
Job summary
Job definition - Responsibilities & Duties
KSAs (knowledge, skills & ability) & competency
Machines, tools, equipments, materials
Relation with other jobs
Nature of supervision & accountabilities
Working environment & conditions
Process of preparation of JDs
Observation of job being performed
Discussion with the supervisor of the job
Getting questionnaire filled up by supervisor
Discussion with employees
Getting questionnaire filled up by employees
Uses of JD
In planning activities including organization design, staffing
levels, career ladders, career paths, job design, pay system
In day-to-day operations including recruitment & screening,
designing selection tests, hiring and placement, orientation,
developing procedures, training and development
In exercising Control to ensure compliance with legal
requirements & meeting union demands especially while
setting performance standards, following legislations,
collective bargaining
Once job analysis has been done organizations need to decide upon the
pay structures. Pay structure refers to the process of setting up the
pay for a job in an organization. The process deals with internal
and external analysis to estimate the compensation package for a

job profile. Internal equity, External equity and Individual equity

are the most popular pay structures. Job description provides the
in depth knowledge about the job profile and its worth.
Pay structures are the strong determinant of employees value in
the organization. It helps in analyzing the employees role and
status in the organization. It provides for fair treatment to all
employees. Pay structures also include the estimation of incentives.
The level of incentives also depends on the level of job position in the
organizational hierarchy.
Internal Equity
The internal equity method undertakes the job position in the
organizational hierarchy. The process aims at balancing the
compensation provided to a job profile in comparison to the
compensation provided to its senior and junior level in the
hierarchy. The fairness is ensured using job ranking, job
classification, level of management, level of status and factor

External Equity

Here the market pricing analysis is done. Organizations formulate

their compensation strategies by assessing the competitors or
industry standards. Organizations set the compensation packages
of their employees aligned with the prevailing compensation
packages in the market. This entails for fair treatment to the
employees. At times organizations offer higher compensation
packages to attract and retain the best talent in their

The first thing employers should consider when developing compensation

packages is fairness. It is absolutely vital that businesses maintain
internal and external equity. Internal equity refers to fairness between
employees in the same business while external equity refers to relative
wage fairness compared to wages with other farms or businesses. No
matter the compensation level, if either internal or external equity is
violated, a business will most likely experience employee dissatisfaction
and employees with begin to balance their performance through a variety
of ways ranging from decreased productivity to absenteeism and
eventually to leaving the business.
So, what constitutes a fair wage? One approach to determining a fair
wage is a market survey. These are typically fast and easy ways to
establish compensation guidelines for many businesses. A few phone

calls to other employees in similar businesses can determine the "market"

value for a specific job.

Job evaluation can be defined as a systematic procedure designed
to aid in establishing pay differentials among jobs
*Compensation: Milkovich, George T. and Jerry M. Newman; BPI/Irwin, 1990; p. 103.

Process to determine and compare the demands which

the normal performance of particular jobs makes on normal workers
without taking into account of the individual abilities or performance
of the workers concerned

Process of analysis & assessment of jobs to ascertain

reliably their relative worth using the assessment as a basis for a
balanced wage structure

Rating of the jobs to determine their position in a job


Widely used in the establishment of wage rate

structures & elimination of wage inequities

Applied to jobs rather than the qualities of individuals

on the jobs

Basic goal is to ascertain the relative worth of each job

through an objective evaluation so that relative remuneration may be
fixed for different jobs.

A systematic procedure which enables wage structure

to be fair & equitable
Some Principles of Job Evaluation

Clearly defined and identifiable jobs must exist. These jobs will be
accurately described in an agreed job description.

All jobs in an organisation will be evaluated using an agreed job

evaluation scheme.

Job evaluators will need to gain a thorough understanding of the


Job evaluation is concerned with jobs, not people. It is not the

person that is being evaluated.

The job is assessed as if it were being carried out in a fully

competent and acceptable manner.


Job evaluation is based on judgement and is not scientific.

However if applied correctly it can enable objective judgements to be

It is possible to make a judgement about a job's contribution

relative to other jobs in an organisation.

The real test of the evaluation results is their acceptability to all


Job evaluation can aid organisational problem solving as it

highlights duplication of tasks and gaps between jobs and functions.


- Job evaluation is a step ahead of Job analysis
- Job analysis is not concerned with the calculation of a jobs worth
while job evaluation is the basis for a balanced wage structure
- Job analysis is only concerned with the collection of data
concerning the particular job while Job evaluation follows the job
analysis which provides basic data to be evaluated
- Job evaluation measures the value of JDs & translates it in terms
of money to have a balanced wage structure
- Job evaluation starts from job analysis & ends with the
classification of jobs according to their worth
Establishing a sound wage foundation for incentive & bonus
Maintaining a consistent wage policy
Enabling management to gauge &control its payroll costs more
Provide framework for periodic review of wages & salaries
Classify functions, authority & responsibility which in turn aids in
work simplification & elimination of duplicate operations
Reduces employee grievances and labor turnover thus increasing
employee morale & improving management-employee relationship
Serves as a basis for union negotiations
Valuable technique for management to establishing a
rational & consistent wage & salary structure both internally
& externally

Helps in bringing harmonious relations between labor &

management by eliminating wage inequalities
Standardizes process of determining wage differentials
Takes into account not only skill differences but other factors
like risks, working conditions also all relevant factors taken
into consideration
Provides a rate for the job not for the man
Helps keep down costs of recruitment & selection of workers,
retaining workers
No standard list of factors to be considered for job evaluation
Lacks scientific precision - All job factors cannot be
measured accurately
Wages fixed for a job on basis of job evaluation may not
retain them
Individual merit is ignored which is not appreciated by
workers & employees
Presumes that jobs of equal worth will be attractive but not
so in reality as there are no prospects of a rise
Is inflexible, which does not have high chances of survival in
a dynamic environment
Regarded with suspicion by trade workers as methods are
not scientific & often are difficult to understand
A thorough examination of the jobs
Preparation of JDs & analysis of job requirements
Comparison of one job with others
Arrangement of jobs in their corrective sequence in terms of
value to the firm
Relation of the sequence to a money scale
Should be carried out with a high degree of integrity &
fairness; calls for mutual trust between management and
unions; evaluators must have wide knowledge of the jobs;
workers must be informed of the purpose & assurance must
be given that no pay-cuts due to job evaluation will happen


1 Ranking or job comparison
2 Grading or job classification
1 Factor comparison method
2 Point rating method

Ranking simply orders the job descriptions from smallest to largest based
on the evaluators perception of relative value or contribution to the
organizations success.
This method is one of the simplest to administer. Jobs are compared to
each other based on the overall worth of the job to the organization. The
'worth' of a job is usually based on judgments of skill, effort (physical
and mental), responsibility (supervisory and fiscal), and working

Very effective when there are
relatively few jobs to be evaluated
(less than 30).

Difficult to administer as the number

of jobs increases.
Rank judgments are subjective.
Since there is no standard used for
comparison, new jobs would have to
be compared with the existing jobs to
determine its appropriate rank. In
essence, the ranking process would
have to be repeated each time a new
job is added to the organization.

Ranking Methods
1. Ordering Simply place job titles on 3x5 inch index cards then
order the titles by relative importance to the organization.
2. Weighting
3. Paired Comparison

After ranking, the jobs should be grouped to determine the appropriate

salary levels.
Jobs are classified into an existing grade/category structure or hierarchy.
Each level in the grade/category structure has a description and
associated job titles. Each job is assigned to the grade/category providing
the closest match to the job. The classification of a position is decided by
comparing the whole job with the appropriate job grading standard. To
ensure equity in job grading and wage rates, a common set of job grading
standards and instructions are used. Because of differences in duties,
skills and knowledge, and other aspects of trades and labor jobs, job
grading standards are developed mainly along occupational lines.
The standards do not attempt to describe every work assignment of each
position in the occupation covered. The standards identify and describe
those key characteristics of occupations which are significant for
distinguishing different levels of work. They define these key
characteristics in such a way as to provide a basis for assigning the
appropriate grade level to all positions in the occupation to which the
standards apply.


The grade/category structure exists
independent of the jobs. Therefore,
new jobs can be classified more
easily than the Ranking Method.

Classification judgments are

The standard used for comparison
(the grade/category structure) may
have built in biases that would affect
certain groups of employees (females
or minorities).
Some jobs may appear to fit within
more than one grade/category.

A set of compensable factors are identified as determining the worth of
jobs. Typically the number of compensable factors is small (4 or 5).
Examples of compensable factors are:
1. Skill
2. Responsibilities
3. Effort
4. Working Conditions

Next, benchmark jobs are identified. Benchmark jobs should be selected

as having certain characteristics.
1. equitable pay (not overpaid or underpaid)
2. range of the factors (for each factor, some jobs would be at the low
end of the factor while others would be at the high end of the
The jobs are then priced and the total pay for each job is divided into pay
for each factor. See example matrix below:
Job Evaluation: Factor Comparison
The hourly rate is divided into pay for each of the following


for Pay
for Pay
for Pay
















This process establishes the rate of pay for each factor for each
benchmark job. Slight adjustments may need o be made to the matrix to
ensure equitable dollar weighting of the factors.
The other jobs in the organization are then compared with the
benchmark jobs and rates of pay for each factor are summed to
determine the rates of pay for each of the other jobs.

The value of the job is expressed in

monetary terms.
Can be applied to a wide range of
Can be applied to newly created jobs.


The pay for each factor is based on

judgments that are subjective.
The standard used for determining
the pay for each factor may have
build in biases that would affect
certain groups of employees (females
or minorities).

A set of compensable factors are identified as determining the worth of
jobs. Typically the compensable factors include the major categories of:
1. Skill
2. Responsibilities

3. Effort
4. Working Conditions
These factors can then be further defined.
1. Skill
1. Experience
2. Education
3. Ability
2. Responsibilities
1. Fiscal
2. Supervisory
3. Effort
1. Mental
2. Physical
4. Working Conditions
1. Location
2. Hazards
3. Extremes in Environment
The point method is an extension of the factor comparison method.
Each factor is then divided into levels or degrees which are then assigned
points. Each job is rated using the job evaluation instrument. The points
for each factor are summed to form a total point score for the job.
Jobs are then grouped by total point score and assigned to wage/salary
grades so that similarly rated jobs would be placed in the same
wage/salary grade.

The value of the job is expressed in

monetary terms.
Can be applied to a wide range of
Can be applied to newly created jobs.


The pay for each factor is based on

judgments that are subjective.
The standard used for determining
the pay for each factor may have
built-in biases that would affect
certain groups of employees (females
or minorities).

Job Evaluation - The Future

As organisations constantly evolve and new organisations emerge there
will be challenges to existing principles of job evaluation. Whether
existing job evaluation techniques and accompanying schemes remain
relevant in a faster moving and constantly changing world, where new

jobs and roles are invented on a regular basis, remains to be seen. The
formal points systems, used by so many organisations is often already
seen to be inflexible. Sticking rigidly to an existing scheme may impose
barriers to change. Constantly updating and writing new jobs together
with the time that has to be spent administering the job evaluation
schemes may become too cumbersome and time consuming for the
benefits that are derived.
All of these evaluation methodologies are based on one or a combination
of the following two approaches: (1) an analysis of the job as a whole or
(2) an analysis of the job's individual components.
Most evaluation methods compare jobs in the organization to one another
and a few compare jobs against a set scale. After a review of the various
job evaluation methodologies, the compensation management system will
retain a modified version of the position classification method or whole
job evaluation approach. This non-quantitative whole job approach
determines the relative value of positions by comparing them with job
descriptions as well as with other positions.
Human resource professionals or line managers should be able to assign
positions to the appropriate career groups by comparing the overall
duties and responsibilities listed in the employee work profile to the
concept of work outlined in the career group description. The
compensable factors will be used primarily to determine the appropriate
role to which a position should be allocated within a career group.
Definitions of the three compensable factors are as follows:
1. Complexity of Work
This factor describes the nature of work in terms of resources (e.g.,
machines, manuals, guidelines and forms) used or encountered and the
processes applied. This factor takes into account the number and variety
of variables considered, the depth and breath of activity and the
originality exercised.

Difficulty - the relative character of the work process and the

corresponding, thinking, analysis and judgment required of the employee
while doing the work.
Scope and Range of Assignments - the breadth and variety of the
employee's assignments.
Knowledge, Skills and Abilities - the level of information, experience and
qualifications needed by the employee in order to perform the assigned
Nature of Contacts - the extent of the employee's human interactions
within and/or outside the organization in terms of both frequency and
the depth of information exchanged.
2. Results
This factor describes the work outcomes and the range and impact of
effects, such as the benefit or harm to citizens, the gain or loss of
resources and the goodwill created.
Impact - the range of people, things, and organizations directly affected
by the employee.
Effect of Services - the extent to which decisions and work products
made by the employee affect the level of service, quality of work, welfare
of constituents, the organization's image and cost of operations.
Consequence of Error - the potential costs of the employee's mistakes in
terms of financial and human costs, efficiency, morale, physical
maintenance and image.
3. Accountability
This factor describes the employee's responsibility or authority exercised
in terms of guidance given to fellow workers, independence and
autonomy of functioning and finality of decisions made.
Leadership - the level of control the employee has over resources such as
people, functions, facilities and budget.
Judgment and Decision-making - the types and kinds of decisions made
by the employee and the finality of these decisions and actions taken.
Independence of Action - latitude or freedom of action exercised by the
For the past fifty years, the concept of "jobs" has been the focus of all
human resource practices that affected recruitment, selection,
performance planning, performance evaluation, pay systems, training

and career development. Organizations have hired employees, evaluated

performance, paid salaries, developed skills, and planned careers based
on jobs.
In the 1990s, a new idea gained acceptance in a number of organizations
that more closely aligned human resource practices with organizational
strategies, missions and cultures. A number of organizations' switched
from a traditional job-based structure to a competency-based structure
that emphasized the development and attainment of behaviors,
knowledge and skills compatible with and aligned to the organization's
mission and business strategies.
The focus of competencies is centered on characteristics of the employee,
including behaviors, skills and knowledge that can be demonstrated and
positively affect the organization. Competencies emphasize the attributes
and activities that are required for an organization to be successful.
Therefore, human resource practices using Competency Models tap into
the employee capabilities that are aligned to the organization mission
and business need.
Competency Models when implemented in totality can impact all of the
agency's human resource practices including recruitment, selection,
compensation decisions, performance planning, performance evaluation
and career development.
Like other alternative pay and job evaluation systems, a Competencybased System is fairly labor intensive and requires the agency's
commitment to designate the necessary staff resources during the
development stages. Agencies will also want to consider the financial and
human resources required to administer such a system. Additionally,
Competency-based Systems should not be perceived as a "one size fits
all" approach. It is important that an agency identify the specific work
unit(s) where competencies may be identified that directly and positively
impact the success of employees and the agency.
What are Competencies?
Competencies are identified behaviors, knowledge, and skills that directly
and positively impact the success of employees and the organization.
Competencies can be objectively measured, enhanced and improved
through coaching and learning opportunities. There are two types of
competencies, Behavioral and Technical. Depending on the purpose of

the Competency Model, one or a combination of these competency types

may be used.
Behavioral Competencies are a set of behaviors, described in observable
and measurable terms that make employees particularly effective in their
work when applied in appropriate situations. Behavioral Competency
Models may be designed to describe common or "core" behaviors that are
applicable to employees throughout an agency, or may be more narrowly
defined to reflect behaviors unique to an Occupational Family or Career
Technical Competencies are underlying knowledge and skills, described
in observable and measurable terms that are necessary in order for
employees to perform a particular type or level of work activity. Technical
Competencies typically reflect a career-long experience in an agency.
What is a Competency Model?
A Competency Model is a listing of Competencies that apply to a
particular type of work. Competency Models can include Behavioral
Competencies only, Technical Competencies only, or both. An example of
a Competency Model for Human Resource Professional follows:
Human Resource Professional
Behavioral Competencies
Agency (implies company) Mission Focus
Customer Focus
Achievement Orientation
Technical Competencies
Compensation Expertise
Recruitment/Selection Expertise
Employee Relations Expertise
Employee Benefits Expertise
Training and Development Expertise
How are Competency Models used?
Competency models can serve as a way to integrate human resource
practices under the Compensation Management System. Agencies that
elect to use Competency Models need to consider exactly how they will be

used to support the agency's mission and desired strategic outcomes,

and determine the extent to which Competency Models will impact and
affect the agency's human resource practices. The following is a list of
human resource practices that should be taken into consideration when
determining the purpose and intent of an agency's rationale for using
Competency Models:
Training and Development - connection to agency business need is a
major focus of Competency Models. These models can serve as a tool to
assess employees' current behaviors, knowledge and skills; identify
learning areas for development and improvement and be used for career
planning purposes.
Recruitment and Selection - models can be developed to identify
criteria for recruiting and assessing applicants for agency positions.
Performance Management - models can be used to support the
assessment of employee performance.
Compensation Decisions - models can be developed to determine
internal alignment and how pay will be administered based on defined
competencies (e.g. starting pay, promotions, in-band adjustments, etc.).
How are Competency Models linked to pay?
The Compensation Management System, employee compensation is
based on an evaluation of the following pay factors:
Agency business need;
Duties and responsibilities;
Work experience and education;
Knowledge, skills, abilities and competencies;
Training, certification and license;
Internal salary alignment;
Market availability;
Salary reference data;
Total compensation;
Budget implications;
Long term impact; and
Current salary
Competency Models can be used to help evaluate performance or to
determine internal salary alignment and starting pay. Various formats

may be used to determine actual employee pay rates. Formats can range
from comprehensive inventories of individual competency ratings to pay
matrices that reference a general evaluation of competencies and
Comprehensive inventories provide detailed information that can be used
for development purposes and simpler pay matrices can save time in
determining pay.
With a comprehensive inventory including staged competency rating, an
assessment form (or automated format) may be used. The feedback
provider checks off indicator levels for each competency. This data results
in a competency rating summarized into a total rating score, which is
then mapped to a pay band.
A pay matrix is a point system in which points are accumulated based on
educational level, work experience, and other value added compensable
factors such as licensure, certification and specialized coursework that
lead to a competency level. These pay matrices serve as a guide for
determining pay for new hires and pay adjustments for current
employees. Total pay matrix points are converted to a range of pay on the
pay band. The total matrix points help identify internal alignment
considerations and are used with the other pay factors to arrive at
appropriate pay.
How are Competency Models linked to performance planning and
Competency Models provide the supervisor and employee with a clear
understanding of performance expectations, and address training and
development activities necessary for successful performance. Models that
include specific performance criteria ensure that supervisors and
employees share the same understanding of performance expectations.
Most Competency Models require an employee self-assessment of their
performance that provides input to the supervisor in their appraisal of
the employee. Additionally, some may elicit performance feedback from
other internal and external peers, direct reports and customers.
How is Competency-based System evaluated?
The final step in the development of a Competency Model is the design
and implementation of an on-going evaluation plan to measure the

effectiveness of the model's content and usage. Competency Models must

be reviewed and modified periodically to reflect changes in desired
behaviors and technical knowledge and skills that result from an evolving
work environment. The evaluation plan, at the minimum, should include
the individual(s) responsible for evaluating the Competency Model,
evaluation timelines and may follow the same process used to develop
the original Competency Model.
The Compensation Management System is designed to provide a direct
link between organizational performance and employee contribution and
pay. Skill-based Systems are one method of achieving this linkage.

Skill-based pay refers to a pay system in which pay increases are linked
to the number or depth of skills an employee acquires and applies and it
is a means of developing broader and deeper skills among the workforce.
Such increases are in addition to, and not in lieu of, general pay
increases employees may receive. The pay increases are usually tied to
three types of skills:

horizontal skills, which involve a broadening of skills in terms of

the range of tasks

vertical skills, which involve acquiring skills of a higher level

depth skills, which involve a high level of skills in specialised areas

relating to the same job.

Skill-based pay differs in the following respects from traditional pay

systems which reflect skills differences in a structure consisting of rates
of pay for unskilled, semi-skilled and skilled workers:

Skill-based pay is a person-based and not a job-based, system. It

rewards a person for what he/she, rather than the job, is worth.
Job worth is reflected in a basic rate of pay for minimum skills, but
pay progression is directly linked to skills acquisition (rather than
to general pay increases applicable to all) .

It rewards (and therefore emphasizes) a broad range of skills which

makes the employee multi-skilled and therefore flexible.

It positively encourages skills development.

A skill-based pay system may not necessarily reflect how well the
skill is used, as this falls within the performance component of
pay. But there is nothing to prevent injecting performance criteria
into the system. In such cases the system will be more
performance-oriented than a structure which merely recognizes
different rates of pay for skills.

The system needs to be underpinned by opportunities for training

which is critical to the success of the system. The traditional
structure is not dependent on such opportunities.

Reasons for Skill based Pay

More than ever before in industrial relations history a commonality of
interests in the skills of employees has developed between employers and
employees. Skills provide employees with a measure of protection against
unemployment, as well as opportunities for higher earnings. At the same
time, skills provide employers with an important means of achieving
Many countries today are seeking to advance to more technology and
skill-based industries, while others have become (or are becoming) 'post
industrial' societies, in which the application of knowledge determines
productivity, performance and competitiveness. Comparative advantage
based on, for instance, cheap labour or raw materials, has declined in
importance relative to competitive advantage based on the ability to add
value to a particular resource or advantage. Such comparative advantage
partly (often largely) depends on people - their standards of literacy and
education, work attitudes, value systems, skills and motivation. Critical
today is the ability to innovate and develop clusters of competitive
enterprises in particular industries. For the more industrialized
countries this means 'capturing' some of the key industries of the next
century - micro-electronics, biotechnology, new materials science
industries, telecommunications, civil aviation, computers and software,
robotics and machine tools and entertainment. An employee with skills is
most flexible and productive when he develops a broad range of skills, is
able to learn the next higher skill, develop analytical skills and is also
able to work in a team. Important aspects of today's skills package
include multi-skills, cognitive skills, interpersonal and communication
skills, positive work attitudes and quality consciousness. Training is no
longer only for current competence, but is also to prepare for the next

stage of skills. Thus pay systems which promote current and future skills
needs are increasing in importance among employers.
The impact of rapid technological change, the increasing globalization of
product markets, greater customer choice and the emphasis on quality
necessitate a frequent updating of skills, and flexibility to respond to
rapid changes in the requirements of markets. A flexible workforce, which
is one that is multi-skilled, ensures that production is not interrupted
due to the narrow skills of workers, and that workers are themselves
responsible for the quality of products.

Introducing The System

Introducing a skill-based pay system requires several steps to be taken

and several issues to be addressed:

The skills requirements of the enterprise should be analysed

The availability of resources for training should be ascertained

The jobs to be covered by the scheme should be identified

The individual jobs have to be grouped into 'job families' on the

basis that in each 'family' the skills needs are similar. The skills
within each job family and the tasks needed to perform the job
should be analyzed

The above will lead to an identification of the skill blocks or levels.

The skill level is the pay grade relative to the competence to use
particular skills, and the skill block is the training input which has
to be completed to the satisfaction of the certifying authority in
order to gain entitlement to the extra pay. It is not unusual for skill
levels to consist of several skill blocks, each to be acquired through

Training modules have to be formulated

The way in which certification is obtained that the skill has been
acquired should be agreed upon.


The base rates for 'job families' have to be set, as well as the
payments that will be made thereafter when an employee moves
upwards through the skills route.

The criterion for extra payment is not acquisition of the skill, but
its application.

The period during which the skill should be applied before a new
one is acquired should normally be decided on, as the skill should
benefit the employer who should receive a return on the investment

A difficult question is how obsolete skills should be dealt with e.g.

through retraining or redundancy.

Problems in Skill-based Pay

There are several problems associated with the introduction of skillbased pay which should not be underestimated. They can be extremely
costly having regard to

the extra payment involved

training costs

the fact that some skills may be paid for but used infrequently

the possibility that unusable skills may be acquired unless the

system is properly administered

the fact that it is not always easy for an employer to anticipate

accurately what skills will be needed in a few years' time

The administration of the system is complex, both in regard to

certification of skills acquisition and payment. Therefore, unless
administered properly, the costs can outweigh the productivity and
flexibility gains. Further, the employees who reach the maximum of the
skill levels can be demotivated when extra payments, as distinct from
general pay increases, cease. Therefore the gains from flexibility,
improved quality, the elimination of some jobs and so on depend on the
employer's ability to administer the system properly, making clear also
that it is not the acquisition of any skills, but agreed skills, that fall
within the scope of the scheme. Hence the need to negotiate the system.
It is easier to introduce skill-based pay in an entirely new (greenfield)


site, than in an already existing one where there is in existence a pay

system based on different criteria.

Some of the circumstances which contribute to the success of skill-based

pay are:

the employer's commitment to continuous training and


the value attached by the employer to personal growth and

encouragement of a learning orientation

dismantling strong bureaucratic hierarchies and narrow job


participative management practices, independent and cooperative

forms of work


Appropriate Industries

Skill-based pay systems are most appropriate to enterprises which

depend on a high level of skills, and in which labour costs represent a
relatively small portion of total costs, unlike in labour intensive
industries. Though such pay systems have been commonest in
manufacturing organizations, they are applicable to service industries as
well though the objectives may differ. In banks and airlines, for example,
skill-based pay can be used to encourage people to work in areas where
manpower is most needed at a given point of time due to customer flows.
Skill-based pay is particularly consistent with knowledge-based work.
Advantages of Skilled Based Pay
Among the advantages of skill-based pay are the following:

It contributes to job enlargement and enrichment by breaking

down narrow job classifications.

Flexibility is increased by encouraging the performance of multiple

tasks. It enables job rotation, and filling of temporary vacancies


due, for instance, to absenteeism. It therefore contributes to a

leaner workforce.

It enhances productivity and quality through better use of human


It facilitates technological change, which may meet with resistance

in a purely job-based system.

The higher pay levels, continuous training, and job enlargement

through the broadening of skills, tend to reduce staff turnover.

Elimination of unnecessary jobs can result from a workplace

having broad, rather than narrow, skills. It also reduces the need
for supervision.

Job satisfaction is engendered through employees having greater

control over the planning and implementation of their work.

Broadening of skills leads employees to develop a better perspective

of operations as a whole.

It is an incentive for self-development.

It provides employment security through skills enhancement.

It reduces the need to look to promotion to higher levels (which are

always limited) as the only way to enhance earnings, and it
facilitates the planning of an employee's career development path.

Since the reward flows from the application of a skill and it does
not reduce opportunities for others to similarly increase their skills
and earnings, there is likely to be less competition among

Since the pay increases on account of skills are linked to a

measurable standard, the criticism of subjectivity often associated
with performance appraisals and individual-based performancerelated pay, is avoided

Skill-based Systems reward employees for the range, depth and type of
skills they possess that are key to the organization's work functions and
operations. Additionally, Skill-based Systems may be used to directly link
an employee's compensation to work-related skills learned and used on

the job. As the needs of the organization change, compensable skills can
be added or eliminated to encourage employee development to meet the
changing business needs. Skill-based Systems represent a person-based
rewards system, as opposed to a job-based reward system.
Agencies interested in developing a Skill-based System must identify
what goal(s) they are seeking to achieve. Questions to consider are "what
outcomes or results will be expected from implementing a Skill-based
System?" and "what skill sets are valued?". Some potential answers may
be increased productivity, multi-skilled workforce, acquisition of new
skills needed for changing work environment, increased employee morale,
or to solve a specific problem, issue or need.
In a Skill-based System, the focus is on skill acquisition that can be
observed and objectively measured. Therefore, this type of system is most
commonly found in trades or labor settings. Skill-based Systems can be
designed from two perspectives:

horizontal or breadth of skills where cross training is emphasized

(e.g. a multi-skilled trades worker possess electrical, plumbing, and
carpentry skills); and

vertical or depth of skills where specialization and expertise is

valued (e.g. an electronic technician possesses the entire range of
electrical and electronic skills).
Skill blocks are identified sets of skills, knowledge and tasks that are
required based on the work to be performed. Skill blocks focused on
breadth of skills or the versatility of the individual tend to have an array
of different categories of skills. Skill blocks that focus on the depth of
skills or expertise in a particular area tend to have a more narrowly
defined, specialized set of skills. Determining whether the Skill-based
System will be based on breadth, depth or a combination is a key design
Like other alternative pay and job evaluation systems, a Skill-based
System is fairly labor intensive and requires the agency's commitment to
designate the necessary staff resources during the development stages.
Additionally, Skill-based Systems should not be perceived as a "one size
fits all" approach. It would be highly unlikely, given the workforce, that
an agency would implement a Skill-based System agency-wide for the
entire employee population. It is important that an agency identify the
specific work unit(s) where observable and measurable skills may be

identified and would contribute to the overall success of the work unit(s)
and agency.
While there are many benefits to implementing a Skill-based System
under the right circumstances, it is not totally free from potential risks.
Poorly designed Skill-based Systems can lead to paying for skills that are
not used or not relevant to the business needs of the agency. Employees
may reach their maximum pay rates with the attainment of the entire set
of identified skills which limits opportunity for further salary increase
but allows for a fully skilled workforce. Paying employees based on skills
attained and used makes it more difficult to make pay comparisons with
the labor market that focuses on job-based rather than individual skillbased comparisons. Agencies will need to convert skill blocks into
benchmark descriptions in order to continuously review and match
salary reference data.
What are skills and skill blocks?
Skills are the basic components of a Skill-based System. These skills
typically are grouped into skill blocks that include predefined set of
skills, knowledge and tasks. When performed by employees, these skill
blocks will add value to the work process and increase the likelihood of
the work unit's success. Skills and skill blocks should be directly related
to the business needs of the agency. Based on business needs, agencies
should encourage employees in a Skill-based System to achieve the
highest potential skill level required.
As more skill blocks are acquired and are used, the potential value of the
employee increases.
How are Skill-based Systems used?
Skill-based Systems can serve as a way to integrate human resource
practices under the Compensation Management System. Agencies that
elect to use Skill-based Systems need to consider exactly how they will be
used to support the agency's mission and desired strategic outcomes.
Furthermore, agencies will need to determine the extent to which this
type of system will impact and affect the agency's human resource
practices. The following is a list that should be taken into consideration
when determining the purpose and intent of an agency's rationale for
using Skill-based Systems.


Training and Development - connection to agency business need

is the cornerstone to Skill-based Systems. The agency's commitment
to learning is vital to the success of the system. Employees must be
given the opportunity to acquire the knowledge and/or skills required
for the progression through the skill blocks. The skills identified
within a skill block may serve as curriculum for training. Training
plans should be well documented, include specific training objectives
and communicated to employees.

Recruitment and Selection - systems can be developed to identify

knowledge and skills for recruiting and assessing applicants for
agency positions.

Performance Management - systems can be used to support the

assessment of employee performance.

Compensation Decisions - systems will determine how pay will be

administered based on defined skill blocks and guide other pay
decisions (e.g. starting pay, promotions, in-band adjustments, etc.).

What are the steps for developing Skill-based Systems?

The following is a suggested approach, but agencies need to tailor the
process to meet business needs and objectives.
1. Identify the group of employees to be covered: This step consists of
linking the business goals with the Career Group or agency work unit(s)
that are most appropriate for a Skill-based System. Typically, skill blocks
are created to reflect the skills needed for employees in Career Group(s),
Role(s) or functions within a Role. Skill-based Systems compliment job
and pay structures that have broad Roles and extended pay bands.
2. Gather data: Identify knowledge and skills that are important to the
work unit(s) and can be objectively measured. The use of Focus Group(s)
comprised of Subject Matter Experts (managers and employees) is the
desired method to be used to identify skills and skill blocks. It may be
helpful to initially have the Focus Group(s) identify the tasks performed
in the work unit(s) and then identify the skills needed to perform these
work tasks. The "essential' tasks or skills should be explicitly identified,
organized into skill blocks and rank ordered by degree of difficulty or
complexity. Each skill must be clearly articulated to the point that
verifiable measures or standards of performance can be established.

3. Develop skill and skill inventories: Based on the information identified

in the data collection step, skill inventories are developed that list the
discrete knowledge and skills needed to complete the required tasks. The
skill inventories are helpful to both supervisors and employees for career
development purposes and outline clearly how performance will be
measured and assessed.
How are Skill-based Systems validated?
After the skill blocks and/or skill inventories have been developed, each
skill should be validated. Functional supervisors that have a detailed
understanding of the work and its relationship to business need should
be asked to validate the accuracy of the identified skill blocks and/or
skill inventories. As business needs or skill requirements change,
functional supervisors should provide input to modify the skill blocks
and/or skill inventories.
How are Skill-based Systems linked to pay?
The Compensation Management System, employee compensation is
based on an evaluation of the following pay factors:
Agency business need;
Duties and responsibilities;
Work experience and education;
Knowledge, skills, abilities and competencies;
Training, certification and license;
Internal salary alignment
Market availability;
Salary reference data;
Total compensation;
Budget implications
Long term impact; and
Current salary
Using the skill blocks, agencies determine which skills are compensable.
Market data can be obtained to identify a sub-band or pay band to
support a Skill-based System. Once the sub-band or pay band has been
established, the skill blocks can then be assigned to the continuum.
Thus, the skill blocks become the unit measurement for pay increases
within a sub-band or pay band.


There are a number of design options that should be taken into

consideration when administering pay in a Skill-based System.
Progression through a skill block can be compensated by a variety of
methods including constant dollar amount, increasing dollar amount,
fixed percentage or increasing percentage amount. The timing of pay
increases should also be considered. Oftentimes an agency will want to
establish some limitations on the pay increase process in order to control
cost. For example, a control measure may be to require the employee to
remain at a skill level for a fixed period of time or another option would
be for the agency to establish a policy that sets the maximum increase
an employee may receive during a specific time period.
The timing of pay increases and any cost control measure has a
significant impact on both employee morale and cost escalation.
Consideration should be given to any other type of direct compensation
awards the employee may be eligible for such as recognition awards,
retention and market-based adjustments. Other compensation actions
should support the goals and intent of the Skill-based System.
Procedures must be developed for establishing starting pay for new hires
and/or employees transitioning from a traditional pay and job evaluation
system to a Skill-based System. A key issue during the transition is how
current employees will be moved to the Skill-based System. Key
implementation decisions such as how current employees will be paid
initially under the system need to be determined (e.g. placed at the entry
level or obtain an initial or baseline assessment certifying the employee's
current skill level).
Lastly, consideration must be given to how the agency will handle
employees whose skills diminish (e.g. freeze employee's pay or reduce
How is a Skill-based System linked to performance planning and
Skill-based Systems provide the supervisor and the employee with a clear
understanding of the performance expectations and clearly address the
learning activities that are necessary for successful performance.
Additionally, this type of system helps supervisors and employees to
share the same understanding of expected performance.


Agencies must determine the overall method for determining the

employee's skill level. The process developed will serve as a way to certify
that the employee has met all performance standards established for a
skill block. Evaluation methods to consider include checklists, skill
demonstration or testing. Consideration must be given to the timing of
the performance measure. Questions to be answered include: Will
performance be measured at a designed time (annually, semi-annually,
quarterly)? Will the employee be assessed on skills only one time or will
the continued mastery of the skill be required?
After identifying a method for assessing the employee's skills, the next
step is to identify who will assess the performance. Evaluators can be
managers, technical and functional experts, peers or an assessment
team with optional rotating membership. The evaluation of skills can be
accomplished either by a paper or automated process.
How are Skill-based Systems evaluated?
The skill block(s) and pay mechanism that is established must make
sense in terms of the goal the agency is seeking to accomplish and must
be understandable to employees. An evaluation plan should be
established and implemented to ensure that the Skill-based System is
effectively meeting the agency needs and reflects the desired knowledge
and skills needed by the agency.
It is defined as the compensation predicated upon an employee's level of
skill and educational attainment. Knowledge-based pay can be an
incentive for employees to acquire additional training and education,
thus upgrading overall work force skills. Pay-for-learning programs, also
known as pay-for-knowledge, skill-based compensation, knowledge-based
pay, or pay-for-skill programs can be defined as follows: Pay-for-learning
structures link pay to depth or breadth of the skills, abilities, and
knowledge a person acquires that are relevant to the work. Structures
based on skill pay individuals for all the skills for which they have been
certified regardless of whether the work they are doing requires all or just
a few of those particular skills. Simply put, pay-for-learning programs
compensate employees for knowledge and skills that they posses, not for
the job in which they are performing.


The critical processes to determine a skill-based structure should include

the following steps. An organization must make sure that there pay-forlearning structure is:
1) Internally aligned with work relationships within the organization,
perform a
2) Skill analysis: a systematic process to identify and collect information
about skills required to perform work in an organization, select
3) Skill blocks,
4) Skill certification, and,
5) Skill-based structure. Skill analysis decisions also include: what is the
objective of the plan, what information should be collected, what
methods should be used to determine and certify skills, who should be
involved, and how useful are the results for pay purposes. Upon
answering these questions in their respective order, it is important to
remember that skill-based systems focus on inputs, not results. There
success is closely correlated with how well the plan is aligned with an
organizations strategy. The information that is collected should be very
specific information on every aspect of the production process. There are
many different methods used to verify certification of skills, some
companies use peer review, on-the-job demonstrations, tests, and also
completion of formal courses related to certain subject areas. The most
important group of people that should be involved in building a skillbased structure, are the employees of an organization. Employee
involvement is almost built into skill-based plans, as there opinion in all
levels will ensure that they find the pay-for-learning system to be fair.
Skill-based pay systems can be found in some form in approximately 5 to
8 percent of U.S. corporations. They are usually applied to so-called
blue-collar work, most of these firms are in manufacturing and assembly
work where the work can be specified and defined. The advantage of a
skill-based plan is that people can be deployed in a way that better
matches the flow or work, thus avoiding bottlenecks as well as idle
hands. So far skill-based pay systems, particularly multi-skill-based
systems, have been thought to be most successful and have been
implemented with the greatest ease in new plants with a participative
team management style. In a participative new plant environment, such
systems fit the management style, reinforce employees for learning new
skills, and implementation is easier because traditional attitudes about
job ownership don't have to be overcome. In established planes, such
systems are more difficult to implement precisely because of traditional

views about job ownership but offer the possibility of breaking down
such views and providing an incentive for veteran employees to learn new
Using Pay-for-Learning Systems
As stated before, pay-for-learning plans can focus on depth or breadth. In
fact, there are two basic forms of skill-based pay systems, increasedknowledge-based systems and multi-skill-based systems.
Increased-knowledge or depth deals with specialists, such as: specialists
in corporate law, finance, or welding and hydraulic maintenance. These
are a few examples to help understand that specialists are likely paid
based on their knowledge as measured by education level. Increased
knowledge-based systems pay employees based upon the range of skills
they possess in a single specialty or job classification. These are probably
the most common skill-based pay systems and at their simplest are
nothing more than technical skill ladders. For example, skilled trades
often have a pay scale that increases as employees acquire additional
skills and move from an entry to a journeyman level. Similar pay
progressions based upon skill level can be found in universities, law
offices, and research and development labs. Increased knowledge based
systems are sometimes called "Vertical" systems because pay is tied to
the depth of knowledge or skill in a defined job.
Multi-skill based systems or breadth deals with generalists with
knowledge in all phases of operations including marketing,
manufacturing, finance, and human resource. Employees in a multi-skill
system earn pay increases by acquiring new knowledge, but the
knowledge is specific to a range of related jobs. This means that pay
increases come with certification of new skills, rather than with job
assignments. Multi-skilled based systems are a newer, less common, and
more revolutionary form of skill-based pay. In this case, pay progression
is tied to the number of different jobs an employee can perform
throughout the entire organization. For example, in a manufacturing
environment, employees might be paid higher rates based upon their
ability to perform jobs upstream and downstream from their normal
assignment in the production process. Maximum pay rates would be paid
to employees who can perform most or all jobs within the plant.


Because they tie pay to the number of different jobs a person can
perform, Multi-skilled-based systems are sometimes called horizontal
systems. These will enhance the benefits of greater labor flexibility and
job mobility for employees.

Advantages of Pay-for-Learning Systems


Greater Flexibility
Leaner Staff
Improved Problem Solving
Improved Horizontal Communication
Improved Vertical Communication
Supports Employment Security
Improved Lob Satisfaction

Limitations of Pay-for-learning

Increase in Labor Costs

Increase in Training Costs
Increased Administrative Costs
Potential bureaucracy

Real World Use of Pay-for-Learning Systems

There are well-known companies using pay-for-learning systems. AT&T,
Corning, Ford Motor Company, General Mills, General Motors, Maxwell
House, and Volvo to name a few. General Mills uses four skill categories
corresponding to the steps in the production process: materials
handling, mixing, filling, and packaging. Each skill category has three
blocks: 1) entry level, 2) accomplished, and 3) advanced. An employee
can start at entry level and after becoming certified on the skill needed
for the next block, will be compensated for learning those skills. The
employee can continue this process as allowed.


What is valued

Skill Blocks

Quantify the value

Skill Levels

Mechanisms to translate into


Certification and price skills in external market

Pay structure

Based on skills certified/market

Pay increase

Skill acquisition

Managers focus
Employee focus

1) Utilize skills efficiently 2) Provide training 3) Control costs via training, certification, and
work assignments
Seek skills


Skill analysis, and Skill certification


Continuous learning, Flexibility, and Reduced work force


Requires cost controls and Potential bureaucracy



Teams have become a popular way to organize business because they
offer companies the flexibility needed to meet the demands of the
changing business environment. While many companies have been quick
to organize their workforce into teams, they have not been as eager to
implement team-based compensation systems. However, if team-based
organizations continue to utilize old, individually-oriented pay systems,
they will not fully realize the benefit of highly cooperative and motivated
work teams.
Team compensation is a way of rewarding performance in team settings.
That is, individuals are rewarded based on the performance of the team
as opposed to individual performance. There are different kinds of
compensation such as a portion of base pay, other financial rewards such
as gain-sharing, and non-financial rewards such as movie passes and
gift certificates.
Teams are defined as groups of individuals who work together to develop
products or deliver services for which they are mutually accountable.
Because of this new shift in organizational structure, employees are
being Organizations have been using teams more and more to carry out
different functions in the asked to work with others and their collective
performance is evaluated. Traditionally, employees have been
compensated based on their individual performance, but now they are
being evaluated based on how their teams perform. Therefore, it does not
seem to make much sense to compensate employees individually based
on how their whole team performs. Therefore, organizations are moving
toward compensating individuals based on team performance. Team
compensation is a way of rewarding performance in team settings. That
is, individuals are rewarded based on the performance of the team as
opposed to individual performance. Team compensation is often referred
to as team-based rewards or team-based pay. People learn to behave in
certain ways based on the rewards they receive. Therefore, in order to
convey to people that they want them to produce more in teams,
reinforcement of behaviors that lead to and sustain team performance is
necessary. Individual bonuses work against the team, thus lessening the
team spirit.

Some examples of different forms of team-based rewards are: a portion of

the individuals base pay, other financial rewards such as gain-sharing,
and non-financial rewards such as recognition and praise. Gain-sharing
combines pay for performance and employee involvement; as
performance improves, employees share financially in the gain generally
monthly or quarterly. In surveys of the Fortune 1000 companies in 1990
and then in 1993, team-based pay has increased its prevalence and
usage in organizations from 59% to 70% in three years time. Anfuso,
however, warns that only 1 to 20% of the workforce in these
organizations receive team-based incentives.
If companies stress the organizational role of the employee, then the
employee will view their incentives as entitlements based upon that
membership role. This will de-emphasize the "personal" role where they
only think about themselves and not about the organization as a whole.
This helps the organization in that it increases the amount of
commitment from the employee. Team pay has also been associated with
an increased level of motivation. A company needs to be prepared to
support organizational changes in order to reward the new behaviors and
results produced. This allows them to become capable team members.
Therefore, it is recommended that team-based reward systems should be
implemented in order to reinforce team behavior.
Various forms of team-based rewards are used in organizations - they fall
into three categories: a proportion of their base pay, other financial
rewards, and non-financial rewards. 5-10% of the base pay is usually a
sufficient amount to reward individuals. Gain-sharing, defined more
specifically, is another type of financial reward that shares group
improvement in productivity, cost savings, and quality with each
employee in the group. Other types of financial rewards are lump-sum
awards where individuals receive an amount of money that is
independent of their base pay, discretionary bonuses given to teams
based on after-the fact judgment of their performance, and profit sharing
where the employees share a percentage of the organizations profit.
Finally, non-financial rewards are another alternative. For example,
organizations may award teams by recognizing them for exceeding
expectations on the job. Additional examples include coffee mugs, Tshirts, plaques, TV, DVD Player, vacation vouchers etc.
Several companies give team bonuses to sales, management, and
engineering staff. Their performance criteria are based on customer

satisfaction, sales revenue, and market share. It is important to link

employee objectives to company goals. The teams performance is
measured against the team revenue target and the market share. The
bonus is paid quarterly but not to poor performers.
Strategy and culture, are important first steps in any kind of design
process of a team-based compensation plan. Pay sends a loud message to
the employees about what is important in an organization. If teamwork is
what the company wants to emphasize, then it is important that the pay
structure reinforces that behavior. Strategy and culture and
competencies (personal attributes and behaviors such as attitudes,
motives, and traits that predict longer-term success) all need to be
aligned with compensation in order to be effective. Culture is important
in the sense that it tells the organization where you are and allows you to
assess where it is that you want to be. This process allows the
organization to identify missing values, skills, and behavior necessary to
make the transition from one to the other.
Team rewards are very difficult to develop and must be custom-tailored
to the organizations configuration. The effectiveness of rewards depends
upon the review and evaluation processes. Therefore, it is imperative that
organizations set up these programs only when the organization feels
that they have a stable design and has assessed which teams should be
Design Considerations
There are many considerations in the designing of the new compensation
plan. After the alignment of pay with strategy, culture, and competencies
of the employee, then the next step is to determine the type or types of
team in a particular organization. There are four types of teams: The first
is the parallel team that is defined as a part-time team that can be
temporary or permanent that employees participate on in addition to
their normal activities. The second type of team is a process team that
carries out the work processes and is done collectively by members of a
team. A project, or time-based team, is the third type of team and is the
opposite of a parallel team in that members work full-time for the
duration and until completion of a project. A fourth type is a hybrid
organization that includes a mixture of the teams described above.
Another consideration that the organization should take into account is
the number of job categories in an organization. The concept is termed

broad banding, or encompassing more jobs into fewer bands, and it is

used to determine the number of pay grades. The narrower the band, the
fewer the differences, and the greater the equality of pay opportunity
among the people within that band. After determining the bands, one
must determine the parameters used to pay every job. This is the base
pay for each job. Setting base pay is usually based on market pricing and
job evaluations. Market pricing indicates what others in the market
would pay for the same job. Job evaluations assess what skills and work
is involved in a particular job. Also, one must determine the total pay
allocated to the base pay.
The next step in the design of a team-based compensation system is the
performance appraisal stage. The criteria upon which the rewards are
given are necessary in order to create the link between strategy and
reward. An organization must define the performance criteria of their
employees. There are four criteria used in measuring team performance.
The first is a demonstration of behavioral competencies that are personal
attributes and behaviors such as attitude, motives, and traits that
predict longer-term success. The second criterion is the acquisition
and/or the demonstration of skills and knowledge. Thirdly, there needs
to be an achievement of specific objectives within a specified period of
time, best known as management by objectives (MBOs). Finally, the
results (quantitative or qualitative) are used to measure the performance
of the team.
These criteria are different depending on the type of team present in an
organization. The parallel teams would primarily use the MBOs
approach followed by the demonstration of behavioral competencies and
the results of the team effort. In a process team, the primary criterion
used is the demonstration of behavioral competencies followed by the
acquisition of skills and knowledge and results. Finally, in a project team,
the most important criteria is what the results are followed by
demonstration of behavioral competencies and the achievement of
specific objectives in a specified period of time.
Another component of pay is the increase in base pay. Individuals will
sometimes ask for raises and in a team-based environment, it is much
more difficult. One reason for the difficulty lies in the fact that different
types of teams require different ways in which to handle the demands to
increase base pay.

Table 1. Different Approaches to Increase Base Pay as a

Function of Team Type
Team Type Increase Approach

Parallel Merit Increases are desired with team and

regular job performance
Process General Wage Increase
Skill-based Pay
Pay tied to demonstration of Competencies
Peer Evaluations that assess the team members
contribution to the performance of the entire team
Project Merit Increases are desired where the
demonstration of required skills and competencies
are the criteria used to determine whether or not an
increase is in order.

Note: Adapted from Compensation for Teams: How to Design

and Implement Team-Based Reward Systems (p. 125), by S.
E. Gross, 1995, NewYork: American Management
Association. Copyright 1995 by The Hay Group, Inc.

The third component of pay is recognition. Recognizing team results is

very important in the sense that it can motivate team members and
increase the teams level of cohesiveness. If team members are praised for
a job on which they all contributed, their teamwork will be reinforced.
Recognition can actually have more of a motivating effect that reaches
into the future. Non-monetary rewards such as plaques, trophies,
vacation trips, and small gifts can be the best incentive for team
members. However, the most important part of this kind of recognition is
that management must give it with sincerity. In implementing
recognition, the organization must reward teams that exceed objectives,
they must determine who is eligible, and they should have several levels
of recognition. For example, appreciation non-cash rewards, awards for
significant financial contribution, and awards for extraordinary financial
results. It is recommended that non-cash rewards be the primary type of
recognition for all team types, and cash be the secondary reward for
parallel and process teams but not for project teams.
The fourth main component of a compensation plan is the incentive plan.
There are nine basic elements to an incentive plan that needs to be

assessed beforehand. These are eligibility to receive incentives,

participation, measurement, alignment of team and organizational goals,
funding, timing (shorter time between payoffs is better because it raises
motivation), benefits, administration, and evaluation of the whether or
not the plan needs changes.
Implementation of a reward system is the next step after identifying and
assessing the different pay components. There are three phases to
implementation. The first phase is labeled feasibility, which asks whether
the strategy in the organization is feasible at the stage, they are in
currently. It includes planning, environmental assessment, readiness
diagnostic, and the compensation strategy. The second phase is the
design phase and it includes the design concept, the design components,
testing of the compensation strategy, transition approach, union
participation strategy, and administrative requirements. The third phase
is the actual implementation of the program and it includes
education/communication program, organizational integration, and
ongoing monitoring. As mentioned earlier, it is important that the
organization be ready to implement the new compensation system. The
team design needs to be stable before implementing a new pay structure.
The organization must stress communication and flexibility. There must
be management support of teams; the culture must be one of
cooperation; and there also needs to be strong administrative support
that records team performance. Only after these elements are in place
should an organization attempt to design and implement a team-based
compensation system.
For any team-based pay plans to be implemented, there must be a link to
the organizations strategy. Team goals should be subsumed under the
organizations overall goals and objectives. Pay should be aligned with the
accomplishment of those objectives. A performance measurement system
also needs to be established. It is imperative that there are explicit
measures of how well the team is performing in reaching the desired
goals. These measures usually include such factors as productivity and
quality. This is important in meeting goals and also measuring how much
the team members should be paid according to their measured
performance from the predetermined criteria. Another important design
consideration is the allocation method to the team members. Various
methods of distributing rewards - Equal payments to all members of the
team; differential payments to team members based on their contribution
to the teams performance; and differential payments determined by a

ratio of each group members base pay to the total base pay of the group.
The first method fosters cooperation, whereas the second method may
result in some members feeling slighted. A measure of cooperation and
teamwork must be built in to this plan if used. The third ratio method
reflects the market rates of the jobs. The last design consideration is the
payment method. Team rewards should be kept separated from base pay
so that the team member knows that their reward is strictly because of
the performance of their team.
Team pay results in- Improved productivity (Better results are reported
for those using team incentives than those using individual incentives in
a team environment. These results seem to be long-term, as well);
Improved employee satisfaction with the job and pay (This is due, in large
part, to the improvement of their skills through teamwork and to the
greater control over their pay than in the past); Reduced costs
(Production costs are often decreased as employees perform more
effectively and efficiently as a team); Reduced turnover and
absence(because employees feel that they have a stake in the production,
and they are more satisfied); An advantage to the customers is that the
product is improved and the service quality is improved (This is because
the employees start becoming well versed in the operations of the team
and can, therefore, identify some of the important product and service
improvements that can be made).
Because more and more organizations are moving toward the use of
teams to do most of the work, a shift in the way that workers are being
compensated are in order. No longer is it appropriate to reward employees
strictly on how they perform individually when they are no longer
performing individually. Their performance is based solely on how the
team performs. Therefore, organizations need to start compensating
individuals based on how their team performs through team-based
Under whatever circumstances, the compensation plan must be one that
can be communicated easily to the employees. Another consideration
that must be taken into account is fairness. Fairness is subjective, but it
can be remedied by having employees participate in the design of the
compensation plan.

There are a number of prerequisites to an effective teaming environment

that creates a foundation for the reward system. These are:
interdependent jobs; accurate and objective measures of the teams
performance; management support for teams, the organizational culture
emphasizes cooperation among the team members at all levels; there are
effective communication skills and flexible channels between managers
and employees; a flat organizational structure that is ideal in fostering a
team approach, because there are fewer levels of hierarchy; a small group
size that facilitates communication and cooperation; no union or positive
union-management relations that forces a hierarchy on the organization;
there is strong administrative support that records performance based
on team accomplishments; and there are variable external environmental
factors that have flexibility to deal with changing technology.
One must not forget the individual in a team. The rewarding of
individuals is still important, but it must be combined with some sort of
team-based reward as well. The most effective recognition programs are
those that recognize outstanding individuals but also reward the
collaborative efforts of the team. Ideally, individual rewards should
reward the fact that the employee has been a "team player." This helps to
foster an environment of cooperation and collaboration.
All team-based reward systems are different in different organizations.
There is no template that can be placed in an organization to determine
what kind of plan they should use. Finding the "correct formula" for any
particular organization will be the most difficult part, but with a lot of
planning, an organization will be able to find the right mix of rewards for
the teams in their organization.


A Pay Commission is a panel comprised of members of the Union
Cabinet of India for hiking the salaries of government employees. Pay
Commissions were set up to reshape & revise the salary structure of
central government servants.
The Central Pay Commissions were set up in the past at intervals of 10 to
13 years. These Pay Commissions examined various issues such as pay
and allowances, retirement benefits, conditions of service, promotion
policies, etc. and submitted recommendations thereon. The extant rules
do not stipulate any specific time period for constitution of a Pay
Commission for Central Government employees. Till now five Central Pay
Commissions have been constituted as under: Pay Commission

Date of Appointment

Date of Submission of Report

First Pay Commission

May, 1946

May, 1947

Second Pay Commission

August, 1957

August, 1959

Third Pay Commission

April, 1970

March, 1973

Fourth Pay Commission

June, 1983

Three Reports submitted in June, 1986;

December, 1986 and May, 1987 respectively.

Fifth Pay Commission

April, 1994

January, 1997

The first pay commission was constituted in May 1946, and had
submitted its report in a year. The second panel had been set up in
August 1957 and had given its report exactly after two years, with a
financial impact was Rs.396 million. The third pay commission set up in
April 1970 gave its report in March 1973, and created proposals that cost
the government Rs.1.44 billion. The fourth was constituted in June
1983, its report was given in three phases within four years and the
financial burden to the government was Rs.12.82 billion. [1] The Fifth Pay
Commission was set up in 1994 and implemented in 1997 at a cost of
Rs. 17,000 crore. In July 2006, the Cabinet approved setting up of the
sixth pay commission which. The cost of hikes in salaries is anticipated
to be about Rs. 20,000 crore for a total of 5.5 million government
employees as per the 6th Pay Commission. The employees had
threatened to go on a nationwide strike if the government failed to hike
their salaries.

Reasons for the hikes include rising inflation due to the forces of
globalization and liberalization of the Indian economy.
The Class 1 officers in India are grossly underpaid with an IAS officer
after 25 years of work experience earning just Rs.550000 as his take
home pay. Even a fresh graduate can earn Rs.20000 as initial salary but
the person with talent and skill who even earned reputation as good and
result oriented worker in government job is getting much lesser salary
after serving for more than a decade in government department is very
much dejected which reduces his performance leve.

The government should be model employer in all aspects. But if the

burden on taxpayers keeps increasing in return for successively inferior
governments there are only two ways to deal with the situation: Impose a
wage freeze across the board for next 10 yrs and resume revision based
on performance. Alternatively,make the 6th pay commission a permanent
performance evaluation cum pay commission with statutary authority
and appellate remedies to deal with grievances of each organised group
including cadres based on mutually agreed norms by an independent
body of people outside the government.
Sixth Pay Commission
Last year, the central government approved the setting up of the sixth
pay commission to upwardly revise salaries and perks for its 550,000
employees across the country. A cabinet meeting headed by Prime
Minister Manmohan Singh decided that the term of the commission
would be for 18 months. 'The commission will comprise one chairman of
the rank of minister of state, one part time member and one membersecretary of the rank of secretary or additional secretary in the central
government. The proposal is estimated to cost the government an
additional Rs.200 billion ($4.2 billion). The Commission will consider
certain aspects of service conditions of central government employees.
But several guesstimates are being made before the report is announced.
For over four million government employees, including military
personnel, the Sixth Pay Commission may not usher in a dramatic new
era where salaries are more in tune with skyrocketing wages in the
private sector. As per the draft salary structure that is now under
discussion between the commission and the finance ministry, even at the
top-most level the Union cabinet secretary the fixed salary will be
just about Rs.80,000 per month, up from Rs.30,000 earlier.

As head of the Indian bureaucracy, the cabinet secretary notionally runs

Indias largest corporation of almost 3.3 million people, excluding over a
million men in military uniform. His proposed salary wouldnt be a patch
on CEO salaries in the corporate sector, where annual compensation
packages run into crores of rupees for even medium-sized companies.
At the bottom of the totem pole, starting salaries for Class IV employees
would rise from a basic of Rs2,550 to Rs6,500 which is the new
minimum pay for anybody working in government. And the jump is not
as high as it seems since the new basic salary would absorb the earlier
dearness allowance (DA).

7The Wage Board Division comes under Ministry of Labour and
Employment and majorly deals with the following:
81. Payment of Bonus Act, 1965
92. Working Journalists and Other Newspaper Employees (Conditions of
Service) and Miscellaneous Provisions Act, 1955
In the 1950s and 60s, when the organized labour sector was at a nascent
stage of its development without adequate unionization or with trade
unions without adequate bargaining power, Government in appreciation
of the problems which arise in the arena of wage fixation due to absence
of such bargaining power, constituted various Wage Boards. The Wage
Boards are tripartite in character in which representatives of workers,
employers and independent members participate and finalize the
recommendations. The utility and contribution of such boards in the
present context are not beyond question. Except for the Wage Boards for
journalists and non-journalists newspaper and news-agency employees,
which are statutory Wage Board, all other Wage Boards are non-statutory
in nature. Therefore, recommendations made by these Wage Boards are
not enforceable under the law.

The importance of the non-statutory Wage Boards has consequently

declined over a period of time and no non-statutory Wage Board has been
set up after 1966, except for sugar industry, where last such Wage Board
was constituted in 1985. The trade unions, having grown in strength in
these industries, are themselves able to negotiate their wages with the
management. This trend is likely to continue in future.
The Working Journalists and other Newspaper Employees (Conditions of
Service) and Miscellaneous Provisions Act, 1955 (45 of 1955) (in short,
the Act) provides for regulation of conditions of service of working
journalists and non-journalists newspaper employees. The Section 9 and
13 C of the Act, inter-alia, provide for constitution of two Wage Boards for
fixing or revising rates of wages in respect of working journalists and
non-journalists newspaper employees, respectively. The Central
Government shall, as and when necessary, constitute Wage Boards,
which shall consist of
1(a) Three persons representing employers in relation to Newspaper
2(b) Three persons representing working journalists for Wage Board
under Section 9 and three persons representing non-Journalist
newspaper employees for Wage Board under Section 13 C of the Act.
3(c) Four independent persons, one of whom shall be a person who is, or
has been a judge of High Court or the Supreme Court, and who shall be
appointed by the Government as the Chairman thereof.
Since 1955, the government has constituted 5 wage boards at regular
intervals for the working journalists and non-journalist newspaper
employees. The following table gives the details of the constitution of
wage boards and other relevant details: Constitution of Wage Boards for
Working Journalists and Non-Journalists Newspaper Employees in the

Name of

Working Journalists
(a) Wage Board for
Working Journalists
(b) Wage Board for
Newspaper Empl.





Date of acceptance
of recommendations
by the Govt.



submitted to
the Govt










(a) Wage Board for

Working Journalists




Converted into 1
man Tribunals on
9th Feb 1979.

(b) Wage Board for

Newspaper Employees
Working Journalists
Newspaper Employees
Working Journalists
Newspaper Employees









05-12-2000 and

The last Wage Board, namely the Manisana Wage Board, was set up on
2nd September 1994, which submitted its report to the Government on
25th July, 2000. The Government accepted the recommendations of the
Manisana Wage Board, and notified the same for implementation with
minor modifications, vide notifications dated 5.12.2000 and 15.12.2000.
The prime responsibility for implementing the recommendations of the
Wage Board rests with the concerned State Governments / Union
Territories under the provision of the Act.
The newspaper employees unions have been demanding constitution of
fresh Wage Boards as more than 10 years have elapsed after the
constitution of last Wage Board and they felt the last Wage Boards had
not taken into consideration the boom in the newspaper sector on
account of globalization and liberalization.
Although the Working Journalists and Other Newspaper Employees
(Conditions of Service) and Miscellaneous Provisions Act, 1955 does not
say anything about the periodicity of constitution of Wage Boards, it was
felt that the time was ripe for constitution of fresh Wage Boards as more
than 10 years have elapsed since the last Wage Boards were constituted.
The Cabinet in its meeting held on 18.12.2006 approved the proposal for
constitution of two Wage Boards, one for working journalists and another
one for non-journalist newspaper employees, under Sections 9 and 13 C
of the Working Journalists and Other Newspaper Employees (Conditions
of Service) and Miscellaneous Provisions Act, 1955. The Wage Boards
have been given 3 years to submit there reports to the Government.
The present Wage Boards have been constituted vide Notification No.V24040/3/2004-WB dated 24th May, 2007 under the Chairmanship of Dr.

Justice K. Narayana Kurup, formerly Judge High Court of Kerala and

Acting Chief Justice High Court of Madras. Sh. K.M.Sahni, former
Secretary, Ministry of Labour and Employment has been appointed as
full-time Member-Secretary of the Wage Boards. The Wage Boards have
started functioning from Delhi. The Composition of the two Wage Boards
is indicated in the relevant notifications.
Wage boards are constituted under the Working Journalists and other
Newspaper Employees (Conditions of Service) and Miscellaneous
Provisions Act, 1955 that regulates the conditions of employment of
journalists and employees of news agencies and newspapers. It has been
instrumental in recognizing the key role decent working conditions play
in building quality media. The countrys three major journalists groups
the Indian Journalists Union, the National Union of Journalists, India
and the All India Newspaper Employees Federation formed a
confederation to demand that the government made good on promises to
re-launch the countrys wage board system.

Key Definitions
Commission A commission is compensation based on a percentage
of sales in units or dollars.
Competency-based pay A combination of skill-based, knowledgebased and credential-based pay

Cost-of-living adjustment (COLA) Wage increase or decrease

pegged to the rise and fall in the cost-of-living index.
Differential piece rate (Taylor plan) A piecework plan that pays
on the basis of two separate piecework rates: one for those who
produce below or up to standard and another for those who
produce above standard.
Feedback pay Based on aligning pay with strategic business
objectives and then establishing a direct connection between the
holder and his or her part in accomplishing these goals.
Gainsharing plans Companywide group incentive plans that,
through a financial formula for distributing organization-wide
unite diverse organizational elements in the common pursuit of
improved organizational effectiveness.
Guaranteed annual wage (GAW) A plan in which the employer
guarantees the employee a certain number of weeks of work at a
certain wage after the worker has passed a probation period.
Knowledge-based pay Knowledge-based pay rewards employees for
acquiring additional knowledge both within the current job and in
new job categories.
Merit pay Individual pay increases based on the rated performance
of the individual employee in a previous time period.
Open system A pay system where pay ranges and even an
individual's pay are open to the public and fellow employees.
Pay compression A situation in which employees perceive too
narrow a difference between their own pay and that of their
Production bonus system An individual incentive system that
pays an employee an hourly rate plus a bonus when the employee
exceeds the standard.
Profit sharing plans Profit-sharing plans distribute a fixed
percentage of total organizational profit to employees in the form of
cash-deferred bonus amounts.
Salary Pay calculated at an annual or monthly rate rather than

Secret system A compensation system where pay is regarded as

privileged information known only to the employee, the supervisor,
and staff employees such as HRM and payroll.
Severance pay An income bridge from employment to
unemployment and back to employment, provided by some
Skill-based pay An alternative to job-based pay that sets pay levels
on the basis of how many skills employees have or how many jobs
they can do.
Spot gainsharing A gainsharing system that focuses on a specific
problem in a specific department rather than on performance
improvements for the whole organization.
Standard-hour plan An individual incentive plan that sets wages
on the basis of completion of the job or task in some expected
period of time.
Straight piecework An individual incentive plan where pay
fluctuates on the basis of units of production per time period.
Suggestion system A formal method of obtaining employees' advice
for improvement in organizational effectiveness; it includes some
kind of reward based on the successful application of the idea.
Supplementary Unemployment Benefits (SUB) The employer
adds to unemployment compensation payments to help the
employee achieve income security.
Total Compensation Approach Total compensation is made up of
base pay, variable pay, and indirect pay (benefits).
Variable pay Any compensation plan that emphasizes a share
focus on organizational success, broadens the opportunities for
incentives to nontraditional groups (such as non-executives or nonmanagers), and operates outside the base pay increase system.
Wage Pay calculated at an hourly rate.
1. Determination of individual pay - Pay differentials are based on individual differences
in experience, skills, performance; expectations that seniority and higher performance
deserve higher pay; reasons for choosing to pay employees at different rates for doing
the same job include: pay differentials allow firms to recognize that different employees

performing the same job make substantially different contributions to meeting

organizational goals; differentials allow employers to communicate a changed emphasis
on important job roles, skills, knowledge, etc; differentials provide organizations with an
important tool for emphasizing norms of the enterprise without having employees
change jobs; without differentials, the pay system violates the internal equity norms of
most employees, reducing employee satisfaction with pay and making attraction and
retention of employees more difficult; pay differentials allow firms to recognize market
changes between jobs in the same grade without requiring a major overhaul of the
whole compensation system

2. Methods of Payment
a. flat rate -single rate in unionized firms (treating everyone equally)
b. recognizing individual differences - assumes workers are not
interchangeable/equally productive
c. payment for time worked: wage (calculated on hourly basis);
salary (calculated on monthly/annual basis); pay adjusted upwards
through four types of increases: general across-the-board increase,
merit increase, cost-of-living-adjustment (COLA), seniority
d. variable pay: incentive compensation - based on shared
organizational success, available to nontraditional groups &
operates outside base pay, plans need to be based on clear goals,
unambiguous measures; key design factors need to include:
organizational culture (teamwork, trust), timing (minimal risk of
economic downturn), total compensation approach includes:
variable pay puts a percentage of employee's paycheck at risk, pay
rate will not rise above lower base pay if goals aren't met, flexibility
can be built into the system of total compensation, base pay:
matched closely with the competition, variable pay: methods like
gainsharing, lump-sum bonuses, indirect pay: like benefits
e. merit incentives - study shows merit needs to be 6-7%; less
(unmotivate) more (demotivate) in practice merit pay systems fail
because: employees fail to make the connection between pay &
performance, secrecy of reward is perceived by other employees as
inequity, size of merit award has little effect on performance
f. individual incentives - straight piecework, differential piece rate,
standard hour plan, production bonus system, straight sales
commission, variation (salary plus commission) / (salary plus

g. team/group incentives (used when:) there is a strong dependence

among individuals in a group, it is hard to determine which
individual is responsible for the level of achievement because of
interrelated work, the organization wishes to reinforce teamwork,
group planning and problem-solving
h. organization-wide incentives - suggestion systems, gainsharing
incentive plan (Scanlon plan, Rucker plan, ImproShare,
Winsharing), spot gainsharing, profit-sharing incentive plan,
Lincoln Electric plan, cash & deferred bonuses,
i. ownership- defined contribution plans vs. defined benefits
j.. people-based pay (alternative to job-based pay) - skill-based pay
(breadth of skills), knowledge-based pay (depth of skills), credentialbased pay (qualification dependent), feedback pay (fulfill strategic
goals research bonus ex. NDSU), competency-based pay (skills +
knowledge + traits + motives),
k. executive pay - executive salaries, bonuses, stock options,
executive perquisites, executive pay package dependent on
comparative performance. The pay design has five underlying
principles: compensation committees consist of stockholders &
directors who link CEO compensation to shareholder returns,
variable performance-based pay is emphasized over guarantees
(bonuses), CEOs are encouraged to invest in company stock (stock
options), performance yardsticks are linked to actual key
productivity indices or to competition, CEOs are held responsible
for cost of capital, forcing them to look for vehicles of growth rather
than amassing wealth
3. Issues in Compensation Administration - pay secrecy or
openness, pay security, guaranteed annual wage (GAW),
supplementary unemployment benefits (SUB), COLAs, severance
pay, pay compression solutions for pay compression - re-examining
how many entry-level people are needed, reassessing recruitment
itself, focusing on the job evaluation process emphasizing
performance, basing all salaries on longevity, giving first line
supervisors the authority to recommend equity adjustments for
victims of pay compression