COMPENSATION MANAGEMENT

What is compensation?
 Compensation refers to all forms of financial returns and tangible services and
benefits employees receive as part of an employment relationship. In other words,
Compensation represents the rewards employees receive for performing their
job, are either: Intrinsic & Extrinsic.
 Compensation of employees measures the total income both wages and salaries and
supplements to wages and salaries earned by employees in return for contributing in
production. (Steven. 2012)
PERSPECTIVE OF COMPENSATION
SOCIETY:
 Pay as a measure of justice. Job losses (or gains) attributed to differences in
compensation. Belief that pay increases lead to price increases.
MANAGERS:
 Return in an exchange between employer and themselves. Reward for a job well done.
EMPLOYEES:
 A major expense. Used to influence employee behaviors and to improve the
organization's performance.
STOCKHOLDERS: Using stock to pay employees creates a sense of ownership.
PURPOSE OF COMPENSATION
1. Improving performance, increasing quality, delighting customers and stakeholders.
2. Controlling labor costs. Retain current employees: When compensation is not
competitive, resulting in high turnover. Reward desire behavior: Effective
compensation plans rewards performance, loyalty, experience, responsibility and
other behaviors. Control cost: Rational compensation helps an organization obtain
and retain workers at a reasonable cost. Facilitate understanding: Easily
understood by human resource specialist, operating manager and employees.
Question: Explain different forms of pay.
PAY FORMS
 The forms of compensation are categorized as:
1. Total Compensation:
1) Cash compensation:
1. Base Pay
2. Merit Pay / Cost of Living
3. Long terms incentives
4. Short terms incentives
2) Benefits:
1. Income Protection
2. Work / Life Balance
3. Allowances
2. Relational Compensation;
1. Recognition & status
2. Employment security
3. Challenging work
4. Learning opportunities
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EXPLANATION OF EACH FORM
1. TOTAL COMPENSATION:
1. CASH COMPENSATION:
 Total compensation returns are more transactional. They include pay received directly as
cash such as base pay, merit, incentives, cost of living and adjustments. Indirectly, as
benefits, such as pension, medical allowances or insurance, programs to help balance work
and life demands, brightly colored uniforms, so pay comes in different forms and programs
to pay people can be designed in a wide variety of ways. Followings are direct pay forms.
1. Base Pay: Base Pay is the cash compensation that an employer pays for the work
performed. Base wage tends to reflect the value of the work or skills and generally ignores
differences attributable to individual employees. Base pay is the initial rate of compensation
an employee receives in exchange for services. It excludes extra lump sum compensation
such as bonuses or overtime pay, as well as benefits and raises. An employee's base pay can
be expressed as an hourly rate or as a weekly, monthly or annual salary. Base Pay is divided
into two types.
A. Wages: A wage is monetary compensation (or remuneration, personnel expenses,
labor) paid by an employer to an employee in exchange for work done. Payment for
the number of hour worked. Workers who are covered by overtime and reporting
provisions of the Fair Labor Standards Act-nonexempt- have their pay calculated as an
hourly wages.
B. Salary: Salary referring to pay for employees who are exempt from regulations of
the Fair Labor Standards Act. Hence, do not receive overtime pay. In other words, a
fixed regular payment, typically paid on a monthly basis but often expressed as an
annual sum, made by an employer to an employee, especially a professional or white-
collar worker. Salary refers to monthly rate of pay, irrespectively of the numbers of
hours put by an employee.
2. Merit Pay / Cost of Living:
 Merit increase are given as increment s to the base pay in recognition of past work
behavior. COLA give the same increase to everyone regardless of performance.
 Living Cost Adjustments; Periodic adjustments to base wages may be made on
the basis of changes what other employers are paying for the same work, changes in
the overall cost of living or changes experience or skill. In contrast to merit pay, cost
of living adjustments give the same increases to everyone, regardless of the
performance.
3. Incentives:
 An incentive is something that motivates an individual to perform an action. Incentives
tie pay increase directly to performance. Incentives differ from merit adjustments.
First, incentives do not increase the base wage, and so must be earned each period.
Second, the potential size of the incentive payment will generally be known
beforehand. Whereas, merit pay programs evaluate past performance for an
individual and then decide on the size of the increase. Incentives can tied to the
performance of an individual employee, a team employees,, a total business unit, or
some combination of individual, team and so on. Incentives are one-time payment
they do not permanently increase labor costs.
 COMPENSATION MANAGEMENT
 Incentive pay workers are given a specific production target; Bonus, Commission,
Piece rate. Stock option (granting employees the right to purchase as specific number
of shares of the company’s stock at a guaranteed price during a designated time
period) eg: Apple, Yahoo, Coca-Cola, Nike (Srivasta. 2010).
 Long term incentives: long term incentives are intended to focus employee
efforts on multiyear results. Typically, they are in the form of stock ownership or
options to buy to stock at specified, advantageous prices. The belief underlying stock
ownership is that employees with a financial stake in the organization will focus on
longer-term financial objectives, return on investments, market share, and return on
net assets and so on.
 Short-term incentives; Short-term incentive metrics are typically financial in
nature, such as revenue growth, return on capital or maximizing profit, and many
companies also include non-financial metrics that are consistent with company
strategy, such as meeting safety or quality assurance hurdles, or delivering on
development of a new business or product.

1. Bonuses: Individuals are rewarded based on attainment of performance-based goals

(individual, team and/or company). Goals must be realistic and closely matched to the
business and people involved. Payout potential should be large enough to be significant
to the individual. Bonuses can be set up to directly drive and support the company’s
needs (for example, profitability, annual results, successful completion of projects
and/or significant project milestones).
2. Profit sharing: Payment is tied to company profits. A pre-determined percentage of
profit is shared among all employees. Profit-sharing bonuses are generally paid out once
a year in the form of cash or on a deferred basis.
3. Stock options: An individual receives the option to buy company shares for a set
price during a specified time frame. Option can be exercised by the individual at any
time during the agreed-upon term and subject to any vesting schedule. Stock options
are often part of management’s executive compensation but may be offered to key
employees in lieu of a higher salary—especially where the business is not yet profitable
and/or cash flow is constrained. If the business does well and the company’s stock rises,
the holders of the options share in the financial benefits. In general, if the company
permits a long period from the date of issue to the last date for exercising the option, it
will encourage the employee to stay with the company and be fully committed to its
success.
 COMPENSATION MANAGEMENT
2. Benefits:
 The benefits that include income protection, work, life and allowances are also part of total
compensation. The following benefits are indirect form of pay.
1) Income Protection: Medical insurance, Life insurance, Disability income, Saving
Plans, Pension, Social security, Allowance (house, meal, transportation, wedding). All these
income protection benefits help to protect employees from the financial risks inherent in
daily life.
2) Work / Life Balance: these are the programs that help employees better integrate
their work and life responsibilities include time away from work (Pay for time not work),
Also called as supplemental benefits, Vacations, Holidays, Sick leaves (out of work due to
illness), Maternity leave, Paternity leaves, jury duty and so on, access to these services to
meet specific needs drug counseling, financial planning, referrals for child and elder care)
and flexible work arrangements including telecommuting, nontraditional schedules,
nonpaid time off and so on.
3) Allowances: allowances such as accommodation allowances, mean, clothing
allowances, travelling allowances, reimbursing allowances (to cover on the job expenses
such as meals, mileage, or tools) and so on. These allowances are given to employees in
order to retain and attract employees and make them motivated to do their work well.

2. RELATIONAL COMPENSATION
1. Recognition & Status:
 Communication between management and employees which rewards them for reaching
specific goals or producing high quality results in the workplace. Recognizing or
honoring employees for this level of service is meant to encourage repeat actions,
through reinforcing the behavior you would like to see repeated.
2. Employment Security:
 Employment security is about the protection of workers against fluctuations in earned
income as a result of job loss. ... One of the forms of protection that is afforded to workers
against, or upon, dismissal, is provided by employment protection legislation (EPL).
3. Challenging Work:
 Challenging work can be a great motivator, as it can keep employees engaged and interested
in their role. For many people, having to overcome some level of difficulty in their work is
much preferable to the boredom of an easy, unchallenging job. Therefore, when employees
perform challenging work provide them with compensation, plusses and etc….
4. Learning Opportunities:
 The employees should be provided learning opportunities for their development and
promotion, it can be providing scholarships to complete their Masters, and enhance their
higher education. Or providing them training and seminars for learning new things about
their job such as technology, new techniques and so on.
 COMPENSATION MANAGEMENT
FOUR POLICY CHOICES
1. Internal Alignment:
 Internal alignment refers to comparisons among jobs or skill levels inside or within
a single organization. Internal alignment, often called internal equity, refers to the
pay relationships among different jobs, skills, competencies within a single
organization.
2. External Competitiveness:
 It is refer to the pay comparisons with the competitors. Effects of decisions
regarding how much and what forms: To ensure that pay is sufficient to attract
and retain employees. To control labor costs to ensure competitive pricing of
products/ services. All pay decisions must be made without regard to race, color,
creed, national origin, religion, sex, sexual orientation, age, disability
3. Employee Contribution:
 Focus - Relation emphasis placed on employee. Performance. Generation Ys desire to
be instantly rewarded for good performance which is pay for performance policies
4. Management of the pay system:
 Ensuring the right people get the right pay for achieving the right objectives in the
right way.
Question:
 How internal alignment is linked with organizational strategy, workflow and motivating behavior?
CHAPTER THREE DEFINING INTERNAL ALIGNMENT
 Internal alignment often called internal equity refers to the pay relationships among
different jobs, skills, competencies within a single organization. Internal Alignment
addresses the relationships among different jobs inside an organization form a job
structure that should support the organization's strategy, support the workflow, and
motivate behavior toward organization objectives.
 Pay structure refers to the array of pay rates for different work or skills within a single
organization. The number of levels, differentials in pay between the levels and criteria used
to determine those differences describe the structure.

The link between organizational strategy,

workflow and motivating behavior
1. Internal alignment supports organization strategy:
 COMPENSATION MANAGEMENT

Supports Organization
StrategyThe organization's
strategy indicates how it plans
to achieve its purpose. Internal
job structures aligned to the
strategy help to achieve
it.Supports
WorkflowWorkflowrefers to
the process by which goods and
services are created and
delivered to the
customer.Motivates
Behaviourinternal job and
pay structures influence
employees' behaviour by
providing pay increases for
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promotions, more challenging

work, and greater responsibility
as employees move up in the
job structure.The ability for an
employee to see the linkage
between what he or she does
and the organization's strategic
goals is often called line-of-
sight.STRUCTURES
VARY BETWEEN
ORGANIZATIONSan
internal pay structure is defined
by (1) the number of levelsof
work, (2) the pay
differentialsbetween the levels,
and (3) the criteriaused to
determine those levels and
 COMPENSATION MANAGEMENT

differentials.LevelsOne
feature of any pay structure is
its hierarchical nature—the
number of levels and
reportingrelationships.Because
pay structures typically reflect
the flow of work in the
organization, some are more
hierarchical with multiple levels
and others are compressed with
few levelsDifferentialsThe
pay differences between levels
are referred to as
differentials.Work that requires
more human capital—
knowledge, skills, and/or
abilities—that is performed
 COMPENSATION MANAGEMENT

under less desirable working

conditions, and/or whose results
are more valued is usually
paidmore than work with lesser
requirementsCriteria:
Content and
ValueContentrefers to the
work performed in a job and
how it gets done (tasks,
behaviours, knowledge
required, and so on).
Valuerefers to the worth of the
work: its relative contribution to
the organization objectives.A
structure based on content
typically ranks jobs on the basis
of skills required, complexity of
 COMPENSATION MANAGEMENT

tasks, and/or responsibility. A

structure based on the value of
the work focuses on the relative
contribution of the skills, tasks,
and responsibilities of a job to
the organization's goals.The
universal structure dictates 8
levels for industrial workers, 16
levels for technical and
engineering workers, and 26
levels for government
employees.Use value reflects
the value of goods of services
an employee produces in a job.
Exchange value is whatever
wage the employer and
employee agree on for a
jobJob- and Person-Based
 COMPENSATION MANAGEMENT

Structures A job-based
structurelooks at work content—
tasks, behaviours,
responsibilities. A person-based
structureshifts the focus to the
employee: the skills, knowledge,
orcompetenciesthe employee
possesses, whether or not they
are used on the particular job
the employee is doing.

Microeconomic Factors:
a. Job description
b. Job Analysis.
c. Job evaluation
d. Pay structure
e. Salary surverys.
f. Policies and regulations.
•
Job Descriptions A critical component of both compensation and selection systems, job
 COMPENSATION MANAGEMENT
descriptions define in writing the responsibilities, requirements, functions, duties, location,
environment, conditions, and other aspects of jobs. Descriptions may be developed for jobs
individually or for entire job families.
•
Job Analysis The process of analyzing jobs from which job descriptions are developed.
Job analysis techniques include the use of interviews, questionnaires, and observation.
•
Job Evaluation A system for comparing jobs for the purpose of determining appropriate
compensation levels for individual jobs or job elements. There are four main techniques:
Ranking, Classification, Factor Comparison, and Point Method.
•
Pay Structures Useful for standardizing compensation practices. Most pay structures
include several grades with each grade containing a minimum salary/wage and either step

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increments or grade range. Step increments are common with union positions where the pay for
each job is pre-determined through collective bargaining.
•
Salary Surveys Collections of salary and market data. May include average salaries,
inflation indicators, cost of living indicators, salary budget averages. Companies may purchase
results of surveys conducted by survey vendors or may conduct their own salary surveys. When
purchasing the results of salary surveys conducted by other vendors, note that surveys may be
conducted within a specific industry or across industries as well as within one geographical
region or across different geographical regions. Know which industry or geographic location the
salary results pertain to before comparing the results to your company.
•
Policies and Regulations