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Wages & Compensation Management


CONTENTS

Chapter 1: Introduction to Compensation

Chapter 2: Introduction to Compensation Management

Chapter 3: Job Evaluation

Chapter 4: Reward Management in Tncs (Transnational Corporations)

Chapter 5: Compensation of Chief Executives & Other Employees

Chapter 6: Competency-Based Compensation Systems

Chapter 7: Knowledge-Based Pay

Chapter 8: The Payment of Bonus Act, 1965

Chapter 9: The Payment of Gratuity Act,1972

Chapter 10: Wage Determination


CHAPTER 1
Introduction to Compensation

Meaning of wage/ compensation payment:

Wage is a monetary payment made by the employer to his employee for the work done or
services rendered. It is a monetary compensation for the services rendered. A worker may be
paid Rs. 100 per day or Rs. 4500 per month. This is wage payment. The worker gives his
services and takes payment called wage payment. Industrial workers are paid remuneration for
their services in terms of money called wage payment. Wages are usually paid in cash at the end
of one day, one month or one week. Money wage is the monetary compensation or price paid by
the employer to his employee for the services rendered. Such compensation is also called wage
or salary or reward given by an organization to a person in return to a work done.

Generally, compensation payable to an employee includes the following three


components:Basic compensation for the job (wage/salary)
Incentive compensation for the employee on job
Supplementary compensation paid to employees (fringe benefit and employee services)

Definition:

According to Milkovinch and Boudreau, Compensation refers to all forms of financial returns,
tangible services, and benefits employee received as part of their employment relationship.

Objective/goals of wage & salary:

1. Internal & external Equity: A very important objective in administering wage and salary is
to achieve internal and external equity. Internal equity means similar pay for similar work.
Differences in wages between jobs should be in proportion to the differences in the worth of the
jobs.

2. Fair wages: A fair wage is something more that the minimum wage providing the bare
necessities of life. A fair wage depends on several factor- productivity of labor, prevailing rates
of wages in the same or similar occupations in the same or neighboring region, place of industry
in the countrys economy, employers capacity to pay and so on.

3. Attract competent talent: Through proper wage salary administration, the organization seeks
to attract talented, well qualified and hardworking people.

4. Retain good employees: Through fair and competitive wages and salaries, the organization
aims at retaining competent employees who are doing a good job. The purpose is to reduce
employee turnover.

5. Satisfy employee needs: A key objective of adequate wages and salaries is to help employees
fulfill their various needs. It creates a sense of security and enhances the self-worth of the
employees.

6. Motivate employees to higher productivity: A well planned wage and salary system
motivates employees to work hard, resulting in higher levels of productivity.

Importance of wage payment:

1. To worker: Wage payment is important to all categories of workers. Wage is a matter of life
and death to workers/employees. Their life, welfare and even social status depend on wage
payment. It is only source of income to large majority of workers. They and their unions always
demand higher wages and other monetary benefits.

Majority of labour problems and disputes are directly related to wage payment. The efficiency of
workers and their interest and involvement in the work depend on wage payment. Even their
attitude towards employer depends on wage payment. In brief, wage payment is a matter of
greatest importance to workers. Wage problem is the most pressing and persistent problem
before the entire labour force.

2. To Employer: Wage payment is equally important to employers as their profit depend on the
total wage bill. An employer in general is interested in paying low wages and thereby controls
the cost of production. However, low wages are not necessarily economical. In fact they may
prove to be too costly to the employer in the long run. E.g. In garment manufacturing company if
tailors are not paid properly then it is difficult for the company to retain them. An employer has
a moral and social responsibility to pay fair wages to his worker as they are equal partners in the
production process. He should give fair wages which will benefit to both the parties. Employees
will offer full co-operation to the management when they are paid attractive wages. On the other
hand, strikes and disputes are likely to develop when workers are paid low wages or when they
are dissatisfied and angry due to low wage rates. It is possible to earn more profit by paying
attractive wages to workers. E.g. Reliance, Citi Bank, Motorola are earned huge profits because
of their higher pay packages.

3.To government: Government also give special importance and attention to wages paid to
industrial workers as industrial development, productivity, industrial peace and cordial labour-
management relation depend on the wage payment to workers. Government desires to give
protection to the working class and for this minimum wages act and other Acts are made. In
India, wages are now link with the cost of living. This is for the protection of workers.
Government is the biggest employer in India and the wage rates of government servant and
employees of public sector organisations are decided by government only. Revision of pay scale
of government employees made for adjusting their wages as per the cost of living. For this, Pay
Commission is appointed and pay scale is adjusted as per the recommendations made.

In India, wage payment is very critical, controversial and delicate issue for all categories of work
force. This is due to poverty, rising prices, mass unemployment and rising population. Wage
payment indeed a vexatious problem and needs to be tackled from economic, social and
humanistic angles.

Concept of fair wages: Fair wages is the wage which is above the minimum wage but below the
living wage. Obviously the lower limit of the fair wage is the minimum wage and the upper limit
is set by the ability of the industry to pay. Between these two limits, fair wages should depend on
the factors like

1. Prevailing rates of wages in the same occupation

2. Prevailing rates of wages in the same region or neighbouring areas

3. Employers ability to pay

4. Level of national income and its distribution


5. Productivity of labour

6. Status enjoyed by the industry in the economy

Hence it can be said that fair wages are determined on industry cum region basis. When fair
wages are paid employees enjoy higher standard of living. It is accepted fact that wages must be
fair and reasonable. Wages is fair when the employee is able to meet its essential needs and
enjoy reasonable standard of living. Equal pay for equal work serves as base of fair wage.

According to Encyclopaedia of social science,Fair wages are equal to those received by the
workers performing work of equal skill, difficulty or unpleasantness.

Factors Influencing Wage And Salary Structure:

1. The organizations ability to pay:

Wage increases should be given by those organizations which can afford them. Companies
that have good sales and therefore high profits tend to pay higher wages than those which are
running at a loss or earning low profits because of the high cost of production or low sales.

2. Supply and demand of labour:

If the demand and certain skills are high and the supply is low the result is rise in the price
to be paid for these skills. The other alternative is to pay higher wages if the labour supply is
scarce and lower wages when it is excessive.

3. The cost of living:

When the cost of living increases, workers and trade unions demand adjusted wages to
offset the erosion of real wages. However when living costs are stable or decline the
management does not resort with this argument as a reason for wage reduction.

4. The living wage:

Employers feel that the level of living prescribed in workers budget is opened to argument
since it is based on subjective opinion.

5. Job requirements:
Jobs are graded according to the relative skill responsibility and job conditions required.

6. Trade unions bargaining power:

Trade unions do affect the rate of wages. Generally the stronger and more powerful trade
union, higher the wages.

7. Productivity:

Productivity is another criterion and is measured in terms of output man-hour. It is not due
to labour efforts alone. Technological improvements, greater ingenuity and skill by the labour
are all responsible for the increase in productivity.

8. Prevailing market rate:

This is also known as comparable wages or going wage rate. Reason behind this is
competition demand that competitors adhere to the same relative wage level.

9. Skill levels available in the market:

With the rapid growth of industries, business trade there is shortage of skilled resources.
The technological development, automation has been affecting the skilled levels at a faster rate.

10. Psychological and social factors:

This determine in a significant measure how hard a person will work for the compensation
received or what pressures he will exert to get his compensation increased.

Components of Employee Remuneration:

The remuneration packet of an employee includes wage/salary, incentives, fringe benefits,


perquisites and finally non-monetary benefits.This is made clear in the following chart:

1. Wages and salary:

Wages represent hourly rates of pay, and salary refers to the monthly rate of pay, irrespective of
the number of hours put in by the employee. Wages and salaries are subject to the annual
increments. They differ from employee to employee, and depend upon the nature of job,
seniority, and merit.

2. Incentives:

Incentives are paid in addition to wages and salaries and are also called payments by results.
Incentives depend upon productivity, sales, profit, or cost reduction efforts.

There are: (a) Individual incentive schemes, and (b) Group incentive programmes. Individual
incentives are applicable to specific employee performance. Where a given task demands group
efforts for completion, incentives are paid to the group as a whole. The amount is later divided
among group members on an equitable basis.

3. Fringe benefits:

These are monetary benefits provided to employees. They include the benefit of: (a) Provident
fund, (b) Gratuity, (c) Medical care, (d) Hospitalization payment, (e) Accident relief, (f) Health
and Group insurance, (g) Subsidized canteen facilities, (h) Recreational facilities, and (i)
Provision of uniforms to employees.

4. Perquisites:

There are special benefits offered to managers/executives. The purpose is to retain competent
executives. Perquisites include the following: (a) Company car for traveling, (b) Club
membership, (c) Paid holidays, (d) Furnished house or accommodation, (e) Stock option
schemes, etc.

5. Non-monetary benefits:

These benefits give psychological satisfaction to employees even when financial benefit is not
available. Such benefits are: (a) Recognition of merit through certificate, etc. (b) Offering
challenging job responsibilities, (c) Promoting growth prospects, (d) Comfortable working
conditions, (e) Competent supervision, and (f) Job sharing and flexi-time.

Systems of wage payment:


A) Time Rate System

B) Piece Rate System

Time rate system:

It is the oldest and simplest method of wage payment used extensively in the industrial as well as
government departments. Wages are paid as per the time spent by the workers in the factory. The
production given by them is not taken into consideration. The employer buys the hours of the
workers and pays them accordingly. Time rate system is also called as day wage system. In the
time rate system, efficiency, sincerity, ability is not given attention and all the workers are paid
at one and the same rate as per the period spent in the factory.

Advantages of time rate system:

1) Easy and simple: Time rate is easy to understand and simple to follow and calculate. Wage
calculations are also easy and quick. Each worker knows how much wage payment he is entitled
to at the end of the month. This gives convenience to employer and employees.

2) Guarantee of minimum wage: It gives the guarantee of certain minimum wage payment to
every worker irrespective of their working capacity. Workers get a regular and stable income and
this gives a sense of security to all workers as regards wage payment.

3) Maintains quality of production: Quality of production is maintained here as the workers are
not in a hurry to complete the work. They do not rush the job and spoil the quality because of the
temptation to earn more. Workers tend to work slowly and with care. Even accidents are less as
workers use the machines in a careful manner.

4) Support from trade unions: Workers and trade unions accept and support time rate system as
all workers are placed in one category as regards wage payment. This ensures unity among
workers. Trade unions normally prefer time rate system of wage payment.

5) Avoids quarrels among workers: Time rate avoids heart burning and quarrels among the
workers as uniform wages are paid to all. Here efficiency, honesty and sincerity of workers are
not given any special weightage. Wage rate is the same for sincere and lazy workers.
6) Convenient in modern factory system: Time rate payment is convenient in modern factory
system where production process is continuous and integrated. It is not possible to measure the
work completed by one individual worker and hence time rate system is convenient.

Disadvantages of time rate system:

1) Not scientific: Time rate is not scientific system of wage payment as there is no direct linking
between wages and production/productivity. Wages bill may increase without corresponding
increase in the production. This will bring loss to the employer / management.

2) Absence of positive encouragement: In the time rate system, there is no positive


encouragement to workers to improve their efficiency/ performance as the wage rate is uniform
to all workers; efficient and inefficient.

3) No distinction between workers: In the time rate system no distinction is made between
efficient and lazy workers, both are paid at one rate which is unfair. This system gives
punishment to sincere and efficient workers. They are discouraged as they are paid less than
what they deserve. They may even leave the job.

4) No initiative to workers: Time rate fails to encourage workers to take more interest and
initiative in their work. In fact, it encourages them to follow go slow policy. This is because
wage payment is not linked with the production given.

5) Labour cost may increase: In the time rate system, there is a possibility of increase in the
labour cost without corresponding increase in the production. Workers may work with slow
speed, give less production but collect the wage as per time or day fixed.

6) Strict supervision: In the time rate strict supervision on the workers is essential as payment is
for period and not production. This raises the expenditure on supervision.

7) No effect on productivity/ efficiency: Time rate fails to raise productivity and efficiency of
labour force. It is not an incentive system of wage payment.

Piece rate system:


This is another basic system of wage payment. It is just opposite to the time rate. It is also treated
as an incentive wage system as it encourages workers to produce more and also to earn more. In
the piece rate system, wages are paid as per the output or production given by the worker and not
as per the time spent by the worker in the factory. Payment is by results in terms of output given.
Wage rate is fixed per piece of work or for certain quantity of production. The production given
by a worker at the end of the day is counted and payment is made accordingly.

Merits/ advantages of piece rate system:

1) Linking of wages with production: Here wages are linked with production or productivity. It
raises the productivity of labour. Workers work with speed and use their capacity fully as the
wage payment is directly related to the quantity of production given by a worker.

2) Distinction is made between efficient and inefficient workers: Distinction is made between
efficient and inefficient worker and full justice is done to efficient worker as he gets payment in
proportion to the production given. Efficient workers support the piece rate system but it is not
preferred by unskilled and inefficient workers. They get less payment under this method as their
capacity to produce is less.

3) Encourages workers to take initiative in the work: Piece rate system encourages workers to
take more interest and initiative in the work as every worker gets full reward of his efforts. There
is direct efforts-reward relationship in the piece rate system.

4) Fair to employer and employees: This system is fair to employers as well as employees. The
employees get income in proportion to production given by them and the employer gets
production in proportion to the wage paid.

5) Incentive system: This system serves as the incentive system. Workers work efficiently and
take interest in the work due to corresponding benefit/ reward in the form of higher wage
payment.

6) Limited supervision adequate: In this system strict supervision on the workers is not necessary
as workers work sincerely. This is because their wage payment is directly linked with their
sincerity and ability.
7) Freedom of work to workers: Workers get more freedom of work and there is effective control
on the cost of production in the piece rate system.

8) Brings cordial relations: Piece rate brings cordial labour- management relations and industrial
peace.

Demerits/limitation of piece rate system

1. No guarantee of minimum wage payment: There is a guarantee of certain minimum wage


payment to a worker. This may prove to be dangerous particularly to a newly recruited worker
and workers who are below average.

2. Workers suffer even when they are not at fault: Sometimes workers suffer in wage payment
even when they are not fault. Due to power failure, etc they may not be able to give production
and naturally they will not be eligible for wage payment even when they remain present in the
factory for the whole day.

3. Complicated system: Piece rate system is complicated and difficult as it is difficult to


understand by ordinary workers. Management will have to keep elaborate records of production
given by each worker. Workers also make complaints as regards wage payment when they feel
that due payment is not made to them.

4. Disturbs unity of workers: Piece rate affects the unity among workers as wage payment will
not be uniform to all workers. This will lead to quarrel among workers. Trade unions oppose
piece rate system on the ground that it will lead to rivalry among workers and destroy unity
among them.

5. Not fair to trainees: Piece rate system is not fair to trainees, as their capacity to produce is less
and naturally they will get less wages.

6. Quality of production is adversely affected: It affects the quality of production as workers may
work with speed and this may bring down the quality of production. In addition the wastages and
spoiled work are likely to increase due to haste on the part of the workers to labour hard and over
strain themselves in order to earn more. This affects the health of workers.
Time rate v/s piece rate systems

Meaning:

Wages are paid as per the time spent by workers.

Wages are paid as per the output or production given by workers.

Old/new system:

Oldest and simplest method of wage payment.

Modern and incentive system of wage system.

Guarantee of wages:

Gives guarantee of certain minimum wage payment to every worker.

Fails to give guarantee of minimum wage payment to every worker.

Support:

Employees and trade unions support time rate system.

Employers and efficient workers prefer piece rate system.

Understanding of system:

Easy to understand and simple to administer.

Complicated system as various recorded and registers are required to be maintained

Distinction between workers:

Distinction is not made between efficient and inefficient workers as all are paid at one and same
rate.

Distinction is made between efficient and inefficient workers. Efficient worker is paid more
while an inefficient worker is paid less.

Effect on production:
Encourages workers to follow go-slow policy and naturally production suffers.

Encourages workers to take more interest in the work and naturally production increases.

Quality of production:

Quality, workmanship of production are not affected, raw materials, machinery are utilised
properly. The spoiled work is also negligible.

Quality, workmanship of production may suffer. Increase in spoiled work and wastage of raw
materials.

Supervision:

Strict supervision is necessary as workers are paid as per the period spent.

Strict supervision is not necessary as workers are paid in proportion to the production given.

Suitability:

Suitable to manufacturing units, also suitable when individual contribution is not easily
measurable.

Suitable when contribution of individual worker is measurable and work is standardised and
repitive in character.
CHAPTER 2
Introduction to Compensation Management
Compensation is an activity by which organizations evaluate the contributions of employees in
order to distribute fairly, direct and indirect monetary and non monetary rewards within the
organization s ability and legal regulations. Compensation can be defined as the financial and
non financial rewards provided by an employer for the time, skills and the effort made available
by the employee in fulfilling job requirements aimed at achieving organizational objectives.
Wage: wage refers to hourly rate or daily rate of pay It is the most frequently used pay basis for
production and maintenance employees (blue collar workers) generally; wage earning employees
are paid only for the actual hours of work.

Forms of compensation:

The three specific forms of compensation are pay, incentives, and benefits.

1. Pay: It is the basic compensation an employee receives usually as a wage or salary

2. Incentive: it is the compensation that rewards an employee for efforts beyond normal
performance expectations. Bonus, commission, and profit sharing plans are incentives

3. Benefit: It is additional compensation to an employee as part of organizational


membership. Health insurance, pension, vacation pay are benefits.

Components of Total Compensation:

An incentive or a reward can be anything that attracts the workers attention and stimulates him
to work.

Macroeconomic Compensation:

Develop a compensation program that recognizes the lifestyle and standard of living of all
employees. To survive in a complex, competitive global economy, all organizations, private and
public must be able to focus on the effective and efficient delivery of the products they are
designed to offer. A key factor in promoting effective delivery of essential goods and services is
the provision of a performance based remuneration system for all workers. Compensation
Management provides a step by step approach for designing a remuneration system that
recognizes job requirements; employee related knowledge and skills and performance related
incentives that link individual, team, work unit, and organization performance. Total
remuneration also includes a host of benefits that protect and expand the lifestyle and health of
workers and their families.

More than ever before, the compensation professional must be able to support all activities that
will make the organization more successful. From the beginning of these organizational redesign
efforts, compensation professionals have been called upon to identify:

1. Jobs in which worker efforts can be combined

2. Unneeded jobs and

3. Possibly jobs in which incompetent, obsolete or unneeded employees are being hidden.

In addition, these same compensation professionals are being asked to redesign compensation
and reward programs to improve employee morale and motivation while keeping labor costs
within specified limits. To assist their organizations in competing while functioning within these
often conflicting requirements, compensation professionals have had to increase their knowledge
and skills dramatically. Because of these advances in knowledge and skills, the importance of the
compensation profession has risen in the managerial professional world.

Compensation and Organizational Strategy

To develop a competitive advantage in a global economy, the compensation program of the


organization must support totally the strategic plans and actions of the organization. The
individuals occupying the executive positions of the organization are responsible for establishing
and developing the strategy of the organization. The overall strategic plans inform all of its
members of the direction the organization wishes to take. Management and organizational
specialists review these strategic plans and take the actions necessary within their domain to
ensure accomplishment of the plans.

For the human resources compensation specialist, the assignment to ensure accomplishment of
organizational strategy begins with determining,
1. The work that must be performed by some work unit or individual.

2. The kinds and levels of knowledge and skills required.

3. The quality of people needed to promote organizational success.

4. The rewards the organization can offer to its members that promote a work culture that
ensures accomplishment of organizational strategy.

Skill Requirement and Organization Compensation

Compensation management is that work does pay off. However, to be successful, the worker
must be willing to accept challenges to solve problems. In solving problems, job opportunities
expand, which leads to the need to take risks and accept challenges. In these situations of
uncertainty, a focus on correctness is necessary to minimize the chance and cost of improper
action. Change is inevitable in the knowledge based world. Living and successful adaptation to
change require the continuous expansion of knowledge and skills.

Compensation System:

The compensation system results from the allocation, conversion and transfer of a portion of the
income of an organization to its employees for their monetary and in kind claims on goods and
services.

Monetary claims on goods and services are wages and salaries paid to an employee in the form
of money or any other form that is quickly and easily transferable to money at the favoritism of
the employee. As medium of exchange, money enables an employee to purchase certain kinds
and amounts of goods and services available in the marketplace.

The total compensation package may be described in many ways, but the classification scheme
used in eight dimensions. Each dimension has a number of compensation components. Each
component has a variety of features. The structuring of features, components, and dimensions
into a compensation system is a job for the compensation specialist. The eight dimensions of
compensation system are;
1. Pay for work and performance: Pay for work and performance includes money that is provide
in the short term like weekly, monthly and annual bonuses/awards and that permits employees to
pay for and contract for the payment of desired goods and services.

2. Pay for time not worked: The number of hours worked per week and the number of days
worked per year have decreased.

3. Loss of job income continuation: Job security is and always has been the primary
consideration for most workers. They want assurance that their jobs and the income derived from
working will continue until they are ready to retire.

4. Disability income continuation: The possibility always exists that a worker will incur health or
accident disability because of these disabilities employees are frequently unable to perform their
assignment.

5. Deferred income: Most employees depend on some kind of employer-provided program for
income continuation after retirement.

6. Spouse income continuation: Most employees with family obligations are concerned with
what might happen if they are no longer able to provide money that will allow their families to
maintain a particular standard of living.

7. Health, Accident and liability protection: when a health problem occurs, employees must be
concerned not only with income continuation but also with payment for goods and services
required in overcoming the illness or disability.

8. Income Equivalent payment: Employees usually find them highly desirable and both employer
and employees find certain tax benefit in them. Perks are tax free to employees and tax
deductibles to employers.

Through work, employees have an opportunity to improve their lifestyle. The analysis of
lifestyle demands and the opportunity for maintaining a current lifestyle and improving it in the
future underscore the importance of job earned compensation.
Determining Rates of Pay:

The differences in pay and compensation packages for different employees relate to the
following correlates or determinants. Each of these correlates relatively simple and
straightforward, but like most factors influencing compensation decisions. Their interaction
become difficult to follow and understand.

1. Kind and levels of required knowledge and skills.


2. Kind of business.
3. Union and nonunion status.
4. Capital intensive versus labour intensive.
5. Size of business.
6. Philosophy of management
7. Total compensation package.
8. Geographic location.
9. Supply and demand of labour.
10. Profitability of the firm
11. Employment stability.
12. Gender difference.
13. Employee tenure and performance.
Compensation Strategy:
Support organization mission and strategy through compensation strategy and tactics that
integrate major organizational groups of employees, organizational leaders, including those
occupying the executive suites and those incharge of human resources and compensation
practices, must be able to recognize and integrate the long-term strategic objectives of the
organization with its short-term tactical requirements. An understanding of how organizational
strategy and its related tactics interact and become integrated is becoming increasingly important
to managers at all elves performing various organizational assignments.

To improve cost and quality competitiveness is an environmental where social and political
problems are becoming increasingly more sensitive and information overload is a problem facing
all organizations and their employees information regarding work requirements, performance
stands, and organizational recognition and rewards programming must be readily available,
complete and accepted.

The compensation system, therefore, must be able to transmit a message that is understood and
accepted by all employees that they are valued contributors to organizational success and that the
organization is willing to share the revenues from its products in an equitable manner with all
members. As organizations begin to modify their focus from an almost completely short-term
view to one that integrates short-term tactical operations with longer-term strategic
considerations, pay and compensation will change to respond to support the achievement of shor-
term goals and long-term objectives.

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
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
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

Theories of Wages: A resume:

Henry George in his book Progress and Poverty, writes: As the employer generally makes a
profit, the payment of wages is so far as he is concerned, but the return to the labourer of the
portion of the capital he has received from the labour. So far as the employee is concerned it is
but the receipt of a portion of the capital his labour has produced. Wages come from the direct
product of the labour itself and they constitute only one part of that product. Wages is the
payment received by an employee in exchange for labour. It may be in goods or services but is
customarily in money. The term in a broad sense refers to what is received in any way for labour,
but wages usually refer to payments to workers who are paid by the hour, in contrast to a salary,
which implies a more fixed and permanent form of income (e.g., payment by the month rather
than by the hour). In economic theory, wages reckoned in money are called nominal wages, as
distinguished from real wages, i.e., the amount of goods and services that the money will buy.
Real wages depend on the price level, as well as on the nominal or money wages.

1. Subsistance theory of wages - iron law of wages

It was Thomas R. Malthus's theory of population that provided the raw material for the first
economic wage theory. Population, according to the theory, is limited by the means of
subsistence: it increases geometrically whereas the means of subsistence increases
arithmetically. David Ricardo translated Malthus's theory into the subsistence theory of wages.
According to this theory, wages in the long run tend to equal the cost of reproducing labor, the
subsistence of the laborer. This theory, often called the iron law of wages , indicated that little
could be done to improve the lot of the wage earner because increasing wages leads only to
increasing the number of workers beyond the means of subsistence.

The subsistence theory was an explanation of the general level of wages in terms of labor supply.
Any increase in the wage rate above the subsistence level would induce an increase in the birth
rate and therefore in the supply of labor. The expanded labor supply would force the wage rate
back to the subsistence level. Any decrease in the wage rate below the subsistence level would
result in starvation and a reduction in the labor supply. Although the market price of labor might
temporarily climb above or fall below the natural price, the two would converge in the long run.
In the industrial world, the theory erred in two ways: (1) improvements in technology have
greatly increased the ease and methods by which subsistence can be attained, and (2) cultural
forces have limited birth rates. Although Ricardo recognized the potential effects of the second
factor, he believed that labor supply rather than labor demand would determine the general wage
level in the long run. Although the iron law of wages seems to have been repealed in the
industrial world, it appears to still be in effect in many other parts of the world. Population
growth holds back economic development in many developing countries. Famine is still part of
the world scene. High unemployment in most of the industrial world and the effects of the Baby
Boom on the American labor force suggest further that Ricardo had a point.

2. Standard of living theory of wages:

Late in the 9th century this theory of wages was propounded which is a modified form of the
subsistence theory of wages. Standard of living theory of wages was first stated by Torres in
1815. According to this theory wages tend to conform to the standard of living to which the
workers have become habituated.

There seems to be some truth in this modified form of the theory, because workers may not
accept wages below their established standard of living. However, the effect of standard of
living on wages in only indirect, because workers cannot get higher wages simply by raising
their standard of living unless higher wages are justified by higher productivity of labour.
Moreover, wages and standard of living are inter-dependent. It is difficult to say, which is the
effect- whether wages determine standard of living or the latter determines the former. In fact,
workers are not accustomed to any fixed standard of living.

3. Residual claimant theory

Francis A. Walker's residual claimant theory may be thought of as an American version of the
wages-fund theory. Here, the workers' demand for wages represents the residual claimant on
output after rent, interest, and profit have been independently determined and deducted.
Assigning wages rather than profits as the residual seems curious, but it does suggest that
distribution of income is a matter of decision. It also permitted Walker to suggest that if labor
increased its productivity without the use of more capital or land, its residual would increase -
the germ of a productivity theory.

4. Wages-fund theory

The short-term version of classical wage theory was the wages-fund theory. As described by
John Stuart Mill, this theory explained the short-term variations in the general wage level in
terms of (1) the number of available workers and (2) the size of the wages fund. The wages fund
was thought to come from resources accumulated by employers from previous years and
allocated by them to buy labor currently. Employers were thought to have a fixed stock of
"circulating capital" for the payment of wages. Dividing the labor force (assumed to be the
population) into the wages fund determined the wage. The theory erred in assuming that a fixed
fund for the payment of wages exists and that it accounts for labor demand. Most workers are
paid out of current production. Employers balance labor costs against other costs in determining
labor demand. Both employers and workers, however, often talk as if such funds exist and as if
they determine the amount of labor services needed. They may also accept the implication of the
theory that any gain to one group is a loss to others.

5. Marginal-productivity theory:

Some of the modern economics explain the determination of wages by means of marginal
productivity analysis. According to this theory:
"Wages in perfect competition tend to be equal to the marginal net product of a labor. By
marginal net product of a labor is meant net addition or net subtraction made to the value of the
total produce of a firm when one unit is added or withdrawn from it".

When an entrepreneur employs a unit of labor, how much he pays to him as wages depend upon
the addition which he makes to the total revenue of the firm. If the addition made to the total
revenue by a labor is $5000, the rate of wages wilt be equal to $5000. The entrepreneur will not
pay him more than the return which he contributes to the total production.

The aim of the firm, as we already know, is to maximize profits. If the net product of a labor is
higher than the amount paid to him. the entrepreneur will go on employing more units of labor.
As he engages more and more units of labor, the net produce on the successive units begins to
diminish. It is not because the successive units of labor are in any way inferior to the previous
units but because of the operation of law of diminishing returns. When the net product of the
labor becomes equal to the rate of wages paid to him, the employer discontinues the employment
of further unit of labor, The last unit which he thinks just worth while to engage is called the
marginal unit. The net addition made to the total revenue of a firm by the marginal labor is
called the marginal net product. The rate of wages paid to the labor tends to be equal to the
marginal net product of the labor employed '<' the margin.

As we have assumed that all units of labor are of the same grade, the remuneration which is paid
to the marginal labor will be given to all the units of labor employed earlier. If any worker
demands more than the marginal net product of the labor, he will not be engaged by the
employer.

Professor Taussing has reproduced the marginal productivity theory of wages in a slightly
refined form. According to him:

"Wages tend to be equal not to the marginal net product but the discounted marginal net product
of the labor employed at the margin".

When goods are produced, he says, they are not sold at the same time. There is a time lag
between the production and the sale of the commodities. The labor receives their remuneration
during the course of production. If the prices of goods fail, the entrepreneur will have to undergo
losses as he has paid the wage to the labor keeping in view the prices of the goods prevailing at
that time. As the entrepreneur has borne the risk, so he should pay little less that the actual
marginal net product of the labor keeping in view the risk of fluctuation of price. Secondly, the
entrepreneur has to pay interest on the capital invested. So a deduction at the current rate of
interest is to be made from the final output of the labor. Thus, we find that wages according to
Taussing tend to be equal not to the marginal net-product but discounted marginal net product of
a labor employed at the marginal.

Criticism on marginal productivity theory of wages:

The theory of marginal net product of wages has been criticized on the following grounds:

(i) The theory assumes that there is perfect competition, among the entrepreneurs and the wage
earners while in the real world there is no such perfect competition.

(ii) The theory assumes that all units of labor engaged are perfectly homogeneous but the fact is
otherwise.

(iii) The theory also assumes perfect mobility amongst the labor but the assumption does not
held good in the real life.

(iv) The theory emphasizes on the demand side of the problem and makes a wrong assumption
that the supply of labor remains constant.

It is dear now that marginal net product theory of wages is true only under certain assumed
conditions. In. spite of the flaws which have been discussed above, it offers a bit satisfactory
explanation of the wages.

Demand and supply theory of wages:

We have studied various theories which explain the determination of wages but they all stand
discredited as they do not offer satisfactory explanation of wages. The modern economist are of
the opinion that just as the price of a commodity is determined by the interaction of the forces of
demand and supply, the rate of wages can also be determined in the same way with the help of
usual demand and supply analysis. Let us now discuss in brief as to what we mean by demand
for and supply of labor.
(A) Demand for Labor:

There are various factors which influence the demand for labor. These factors in brief are as
under:-

(i) Demand for labor is a derived demand. The demand for labor is not a direct demand. It is
derived from the demand for the commodities and services it helps lo produce. If the demand for
a product is high in the market, the demand for labor producing that particular type of product
will also be high. In case, the demand for a commodity is small, the demand for that labor will
also be low.

(ii) Elasticity of demand for the product. If the demand for a particular product is inelastic, the
demand for the type of labor that produces this product will also be inelastic. The demand for
labor will be elastic, if cheaper substitutes of the product are available in the market or the
demand for the commodity it produces is elastic.

(iii) Proportion of labor cost to total cost. If the wages of workers account for only a small
proportion to total cost of a product, then the demand for labor will tend to be inelastic. In a
capital intensive industry, for instance, a slight increase in the workers wages with have little
effect on the unit cost of product; So, the rise in wages will not reduce the demand for labor.

(iv) Availability of substitutes for labor. If the substitutes of labor producing a particular product
are easily available in the market, the demand for labor will then be elastic.

After considering the various factors which influence (he demand for labor, we now take up the
demand price of labor.

Demand Price of Labor:

Marginal Revenue Productivity (MRP). An employer hires labor in order to make profit. He,
while employing a worker, compares the cost of hiring a worker to the contribution he is
expected to make to the total revenue of the firm. So long as the addition made by the labor to
the revenue is greater than the cost of employing him, the entrepreneur will engage that labor. In
other words, we can say that so long as the marginal revenue product of labor is higher than the
cost of employing him, the employer employs that worker. The entrepreneur will continue hiring
the worker up to the point at which the cost of employing a worker is just equal to the marginal
revenue product of the labor.

The marginal revenue productivity of labor due to the operation of law of diminishing returns
decreases, as more workers are put to work. The wage rate also decreases with the fall in the
MRP of labor. Thus the demand curve for labor is downward, sloping (The demand curve for
labor is the MRP curve of the firm as each worker earns what his labor is worth). If we add up
the demand curves for labor of all the individual firms (the MRP curves) we get the demand
curve of the industry, it is the demand of the industry which determines wage rate for labor. The
individual firm in a competitive market has to accept wage rate set in the market.

(B) Supply of Labor:

Supply of labor is the number of hours of work which the labor force offers in the factor market.
The supply of labor for the entire economy is influenced by various factors such as wage rate,
size of population, age composition, availability of education and training, the length of training
period, provision of opportunities for women to work, the social security programmes etc., etc.

The supply of labor for the industry as a whole is less elastic in the short-run. The supply of
labor here depends on the availability of workers in the locality and from the nearby areas and
the willingness of the labor to work overtime. In the long-run, the supply of labor for the industry
is more elastic. The labor can be attracted by offering higher wages, providing training facilities,
making working conditions pleasant etc, So the supply of labor for the industry is of the normal
shape rising upward from left to the right.

Wage Determination:

So far we have discussed the forces operating behind the demand for and supply of labor in the
market. As regards the price or the wage of particular grade of labor, it is determined by the
interaction of the forces of. demand for and supply of labor in the competitive market.

Concepts of living, minimum and fair wages:

1. Minimum Wage
2. Living Wage

3. Fair Wage

Minimum wage

The concept of Minimum Wage stands for different standard of different countries. The fair
wage committee in India has observed that in India the level of the national income is so low at
present that it is generally accepted that the country cannot afford to prescribe by law a minimum
wage must provide not merely for the bare sustenance of life but for the preservation of the
efficiency of the worker. Thus, a minimum wage is one, which may be sufficient to enable q
worker to live in reasonable comfort having regard to all obligations to which an average worker
would ordinally be subject.

The objective of minimum wage

1. To prevent explanation of workers and secure a wage equal to work load.

2. To raise the wages in the industries where they are low, thus prevent sweating in
industry.

3. To promote peace in industry by guaranteeing a wage rate this will enable them to meet
their minimum requirements.

4. Raise the standards of living and efficiency of workers.

Living wage

According to the committee in fair wages,

The living wage represented the higher level of wage and it would include all amenities which a
citizen living in a modern civilized society could afford. After considering various observations
made by Indian authorities, the committee on Fair wages observed, the living wages should
enable to male earner to provide for himself and his family the bare essential of food, clothing
and shelter but a measure of frugal comfort including duration for the children, protection against
ill health requirement of essential social needs and a measure of insurance against the more
important misfortunes including old age.
Fair wage

To bring improvement in the relations between labour and management the industrial truce
resolution was passed in 1947, which provided for the payment of fair wages of labour, govt. of
India appointed a Fair wages committee in 1948, and the committee report was published in
1949. Marshell and Pigou have defined fair wages. Marshell Says, In any given industry wages
are fair relatively to wage in industry in general. Lower limit of fair wages must be the
minimum wage for workers and upper limit will be the industry capacity to pay. However,
between these two limits following factors have to be considered:

a. The productivity of labour

b. The prevailing rate of wages in the same or neighboring locality

c. The place of the industry in the economy

d. The level of national dividend and its distribution

Components of a compensation system

Compensation will be perceived by employees as fair if based on systematic components.


Various compensation systems have developed to determine the value of positions. These
systems utilize many similar components including job descriptions, salary ranges/structures, and
written procedures.

The components of a compensation system include:

Job Descriptions A critical component of both compensation and selection systems, job
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 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


CHAPTER 3
Job Evaluation
Job Analysis
-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

Employment
Training
Organization design and staffing
Compensation
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

Job Description

- 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 design

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

Internal & External Equity

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 comparison.

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 organizations.

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

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 hierarchy
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

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 made.

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 participants.

Job evaluation can aid organisational problem solving as it highlights duplication of tasks
and gaps between jobs and functions.

Job Evaluation Vs. Job Analysis

- 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

JOB EVALUATION

Objectives:

Establishing a sound wage foundation for incentive & bonus programmes


Maintaining a consistent wage policy
Enabling management to gauge &control its payroll costs more accurately
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
Importance
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
Limitations
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
Process
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
Requirements
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

Methods for Conducting Job Evaluation

NON-QUANTITAVE METHODS

1 Ranking or job comparison

2 Grading or job classification

Quantitative Methods

1 Factor comparison method

2 Point rating method

RANKING

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
conditions.

Advantages

Simple.

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

Grouping

After ranking, the jobs should be grouped to determine the appropriate salary levels.

Job Classification

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.
Advantages

Simple.

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

Classification judgments are subjective.

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.

Factor Comparison

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 factor).

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 factors:
Hourly Pay for Pay for Pay for Pay for Working
.
Job Rate Skill Effort Responsibility Conditions

Secretary $9.00 4.50 2.00 2.00 0.50


Admin
$11.00 5.50 2.50 2.50 0.50
Assistant
Supervisor $15.00 6.00 3.50 4.00 1.50
Manager $21.00 9.00 3.50 7.00 1.50

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.

Advantages

The value of the job is expressed in monetary terms.

Can be applied to a wide range of jobs.

Can be applied to newly created jobs. Disadvantages

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).
Point Method

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.
Advantages

The value of the job is expressed in monetary terms.


Can be applied to a wide range of jobs.
Can be applied to newly created jobs. Disadvantages
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.
CHAPTER 4
Reward Management in Tncs (Transnational Corporations)
Remuneration and benefits
Remuneration of employees has a key role in acquiring new employees and is important for
employees as well as for the employers. Pay is the basic resource of living of the employees,
while benefits cover better health care, the possibility of spending holidays in the companys
holiday facilities at a favourable price and also other advantages. The decisions the employers
make concerning remuneration are a factor that has an impact on the expenses of their company
as well as on the ability of selling the products at a competitive price in the market (Treven,
1998). The decisions about remuneration may also enhance the ability of the employer to
compete for employees on the labor market. The rewards he warrants make the standing
personnel either want to keep their jobs or quit.

In developing an international system of compensation and benefits, an organization has two


primary concerns. The first is comparability (Briscoe, 1995). A good compensation system
assigns salaries to employees that are internally comparable and competitive within the
marketplace. For example, the salary of a senior manager is usually higher than that of a
supervisor, and each position should receive an amount within the local market range. The
international organization must also consider the salaries of people who may transfer from other
locations. The second major concern is cost. Organizations strive to minimize all expenses, and
payroll is one of the largest.

Renumeration and benefits are closely tied to local labor market conditions, even when an
organization takes an ethnocentric or geocentric approach. The availability of qualified local
people to fill positions, prevailing wage rates, the use of expatriates, and local laws interact to
influence the level of renumeration and benefits. For example, if there are few applicants
available for positions, the renumeration for those positions generally increases. To reduce
expenses, the international human resources manager might then consider bringing in an
expatriate.
A company usually develops a policy, which could apply globally, to offer salaries and benefits
representing a specific market level. For example, a large successful multinational company that
emphasizes the quality of its products and employees could have a global policy to pay the
highest wages everywhere it operates. Another company could offer top salaries in the country
where it does research and development, yet pay average wages in the country where it
manufactures.

Transnational Corporations

Transnational Corporation means a for-profit enterprise marked by two basic characteristics:

It engages in enough business activities -- including sales, distribution, extraction,


manufacturing, and research and 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, Wal-Mart, 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 plan

- 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 plan

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 behavior

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
operations

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 numbers

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
community:

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

Management challenges concerning International Benefits & Compensation

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 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 housing

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 home

Repatriation allowances

Paid on return of employee to his/her country of origin to live there permanently

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
CHAPTER 5
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

SALARIES AT THE TOP

Salary Co's Co's


Annual pay* hike sales profit

(Rs crore) (%) growth Growth

(%) (%)

CMD, Bharti
Sunil Bharti Mittal Airtel 12.68 78.34 58.47 100.45

Pawan Kant Munjal MD, Hero Honda 15.22 15.74 13.61 -11.68

Rajiv Bajaj MD, Bajaj Auto 2.08 362.2 24.16 10.13


EVP and MD,
Naveen Jindal Jindal Steel 13.54 248 36 23

B Muthuraman MD, Tata Steel 2.2 13.4 15.36 20.41

MD and CEO,
K V Kamath ICICI Bank 2.48 35.51 60.73 22.45

Aditya Puri MD, HDFC Bank 1.28 -1.5 53.93 31.08

CMD, Cadila
Pankaj R Patel Healthcare 9.93 32.4 13.47 24.14

Malvinder Mohan
Singh CEO, Ranbaxy 2.62 -2.23 15.13 70.11

Azim Premji CMD, Wipro 2.53 -1.93 33.49 40.66

ED, Patni
Gajendra Patni Computer 2 26.58 13.96 5.84

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 abroad
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 compensation
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 onwards
Inflation
Demand for competent, talented grew but supply did not match
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 performance
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 down
Highest compensation sectors are:

FMCG
IT
Telecom
Engineering
Durables
Components CEO Compensation

Base Salary
Short-term performance bonuses
Variety of Equity (stock ownership) related components
Severance packages (golden parachutes)
Retirement plans
Wide variety of benefits and perquisites
Benefits and perquisites include:

Company-provided car - Medical expense reimbursement


Parking - College tuition reimbursement for children
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 staff
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 disparity
Increases in compensation received by Chief Executives are far out of line with those
provided to the rest of the workforce

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 performance.

- 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 payments

Managerial remuneration & Companies Act 1956

- The Companies Act, 1956, contemplates five categories of managerial personnel:

- 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
198(1).

- 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 remuneration.

- 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?
Recommendations

- 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 short-term (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


CHAPTER 6
Competency-Based Compensation Systems
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.

Compensable Factors

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 duties.

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 employee.

Competency-Based System

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 Competency-based 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 Group.

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
Teamwork
Consultation
Achievement Orientation

Technical Competencies

Compensation Expertise
Recruitment/Selection Expertise
Employee Relations Expertise
Employee Benefits Expertise
Training and Development Expertise

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;
Performance;
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 expertise.

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 evaluation?

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.

Skill-Based Compensation System

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 competitiveness.
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 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.

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 made.

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 skill-based 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 development

the value attached by the employer to personal growth and encouragement of a learning
orientation

dismantling strong bureaucratic hierarchies and narrow job demarcations

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 resources.

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 individuals.

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
performance-related pay, is avoided
Chapter 7
Knowledge-Based Pay
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-for-learning 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 skill-based 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 skills.

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, increased-knowledge-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 Certification and price skills in external market


translate into pay

Pay structure Based on skills certified/market

Pay increase Skill acquisition

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

Employee focus Seek skills

Procedures Skill analysis, and Skill certification

Advantages Continuous learning, Flexibility, and Reduced work force


Limitations Requires cost controls and Potential bureaucracy

Team Based Compensation

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, T-shirts, 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 rewarded.

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).

Conclusions

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 rewards.

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.
What is valued Skill Blocks

Quantify the value Skill Levels

Mechanisms to Certification and price skills in external market


translate into pay

Pay structure Based on skills certified/market

Pay increase Skill acquisition

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

Employee focus Seek skills

Procedures Skill analysis, and Skill certification

Advantages Continuous learning, Flexibility, and Reduced work force

Limitations Requires cost controls and Potential bureaucracy


CHAPTER 8
The Payment of Bonus Act, 1965
The present Act is the outcome of the recommendations made by a Tripartite Commission,
which was set up the Government of India in 1961. The Government on January 24, 1964
received the recommendation of the Commission. Payment of Bonus Act promulgated on 26th
May 1965 and in the same year it was adopted by the Parliament, which in turn enacted Payment
of Bonus Act, 1965.
The Payment of Bonus Act imposes statuary liability upon the employers of every establishment
covered under the Act to pay bonus to their employees. It further provides for payment of
minimum and maximum bonus and linking the payment of bonus with the production and
productivity.

Section 1. Scope and application This Act extends to whole of India. The Act applies to every
factory where 10 or more workers are working and every other establishment where 20 or more
persons are employed, on any day during the accounting year.

Section 32. Act not to apply to certain classes of employees Nothing in this act shall apply to:-

1. Employees employed by the Life Insurance Corporation of India

2. Seamen

3. Employees registered and listed under any scheme of Dock Workers (Regulation of
Employment) Act, 1948

4. Employees of any industry or establishment, which is carried under the authority of


Central/State Government;

5. Employee of Red Cross Society, university and other educational institutions, hospitals,
chamber of commerce and social welfare institutions established not for profit.;

6. Employees employed by contractors

7. Employees of Industrial Finance Corporation of India, Reserve Bank of India, State


Financial Corporations, Deposit Insurance Corporation, Nation Bank for Agricultural and Rural
Development, Unit Trust of India, Industrial Development of India, Small Industries
Development Bank of India, National Housing Bank and other financial institutions other than
banking company, being an establishment in public sector.

Definitions

1. Accounting Year Accounting Year means:

(i) In relation to a corporation, the year ending on the day on which the accounts and books
are to be closed

(ii) In relation to company, the period for which the profit or loss is placed before its annual
general meeting

(iii) In any other case:

(a) the year commencing on the 1st day of April; or

(b) in case the books are closed on any other day, the year ending the day the accounts and
books are closed.

Agricultural Income as defined under Income Tax Act

Agricultural Income Tax Law means any law for the time being in force;

Allocable surplus- Allocable surplus means:

(a) in relation to an employer, being a company other than banking company which has not
made the arrangement, prescribed under the Income Tax Act for the declaration and payment
with in India of the dividends payable out of its profits in accordance with the provisions of
Section 194 of the Act, sixty seven percent of available surplus in an accounting year.

(b) In any other case, sixty percent of such available surplus.

Appropriate Government

1. In relation to establishment in respect of which the appropriate Government is Central


Government under I.D. Act, 1947;
2. In case of any other establishment, the Government of the State in which the
establishment is situated.

Establishment to include department, undertakings and branches

Where an establishment consists of different departments or undertaking or has branches,


whether situated in the same place or in different places, all such departments or undertakings or
branches shall be treated as parts of the same establishment for the purpose of computation of
bonus under the act.

Available Surplus Available surplus means the surplus computed under Section 5 of the Act .

Award Award means an interim or final determination of an industrial dispute.

Banking Company- means a company as defined under section 5 of the Banking Companies Act,
1949

Company means as defined under Section 3 of Joint Stock Companies Act, 1956.

Co-operative society- means a society registered under Co-operative Societies Act, 1912

Corporation A body established under the provision of Act enacted by the Central or State
Government.

Direct Tax Tax chargeable under Income Tax Act, Super Profit Tax Act, 1963 Companies
(Profits) Act, 1964

Employees other than apprentice getting salary or wage not exceeding Rs.3500/- .(Example
Sweeper).

Employer Employer includes

(i) in relation to factory, the owner or his authorised person


(j) in relation to other establishment, the person who or the authority which, has the ultimate
control over the affairs of the establishment and where the said affairs are entrusted to manager,
managing director or other officials.

Factory- Factory shall have the same meaning as defined under the Factories Act, 1948

Gross Profit Gross profit means the gross profits calculated under Section 4.

Income Tax Act means Income Tax Act 1961

Prescribed means prescribed by rules made under this act

Salary or Wage means all remuneration capable of being expressed in terms of money, which is
payable to an employee in respect of the employment or of work done in such employment
including Dearness Allowance but does not include:

Any other allowance which the employee is for the time being entitled to;
The value of any house accommodation of supply of light, water, medical attendance or
other amenity or any service made available at concessional rate;
Any traveling concession;
Any bonus (including incentive, production and attendance bonus);
Any contribution paid or payable by the employer to any pension fund or provident fund
or for the benefit of the employee under any law for the time being in force
Any retrenchment compensation or any gratuity or other retirement benefit payable to the
employee or any ex-gratia payment made to him
Any commission payable to the employee.

Establishment to include departments, undertakings and branches -Whether situated in the same
place or different places. But in case the accounting year is different and separate balance sheet
is prepared, it shall not form of the same establishment.

Computation of Gross Profit- The gross profit derived by an employer from an establishment in
respect of the accounting year shall,

a. in case of Banking Company, be calculated in the manner specified in the First Shedule
b. in any other case, be calculated in the manner specified in the Second Shedule

Deduction from Gross profits (Sec 6)

(a) Any amount by way of depreciation admissible in accordance with the provisions of
Income Tax Act;

(b) Any amount by way of development rebate, investment allowance or the development
allowance which the employer is entitled to deduct.

(c) Direct tax which the employer has to pay for profit or gain

(d) Such further sum as specified in respect of the employer in the third Shedule

Deduction Specified in the Third Shedule

If the employer is a company :

(a) Dividend payable on its preferential shares

(b) 8.5% of its paid up equity share capital at the commencement of the accounting year

(c) 6% of its reserves shown in its balance sheet at the commencement of accounting year
including any profits carried forward from the previous year.

If the employer is a corporation, further sums to be deducted are:

(a) 8.5% of its paid up at the commencement of the accounting year

(b) 6% of its reserve

If the employer is cooperative or a cooperative society further sums to be deducted are:

(a) 8.5% of the capital invested by such society in its establishment at the commencement of
accounting year

(b) Such sum as has been carried forward as reserve for the accounting year

If it is any other employer, further sums, which are to be deducted, are:


(a) if the employer is an individual, the annuity deposit payable by him

(b) if the employer is a 25% of the gross profit derives from its establishment subject to
maximum of Rs.48000/-

(c) if it is HUF 25% of its gross profit after deducting depreciation or Rs.48000/ whichever is
less.

Calculation of Direct Tax Payable by the Employer (Sec.7) Any direct tax payable by the
employer for any accounting year shall, subject to the following provisions, be calculated at the
rates applicable to income of the employer for that year, namely:

a. in calculating such tax no account shall be taken of

Any loss suffered in previous year

Any arrears of depreciation, which the employer is allowed to add to the allowance of
depreciation

Any exemption conferred on the employer under Section 84 of the Income Tax Act

Where the employer is a religious or charitable institution, the permissible amount under the
Income Tax Act.

Where individual or HUF income tax is be deducted in terms of provisions of Income Tax Act.

Computation of available surplus The available surplus in respect of an accounting year shall
be the profit for the year after deducting there from the sums referred to in Section 6:

a. the gross profit for the accounting year after deducting thereform the sums referred to in
Section 6: and

b. an amount equal to the difference between _

i. direct tax calculated in accordance with the provisions of Section 7 in respect of an


amount equal to gross profited of the employer for the immediately preceding accounting year
and
ii. the direct tax calculated in accordance with the provisions of section7 in respect of an
amount equal to the gross profit of the preceding year after deducting there from the amount of
bonus.

Eligibility for Bonus and its Payment

Every employee who is entitled to receive bonus and has worked for 30 days in the accounting
year.

Disqualification for Bonus

a. Fraud
b. Riotous or violent behaviors
c. Theft, misappropriation, or sabotage of any property
Minimum Bonus
8.33% of the salary or wages one hundred rupees to an who has not completed 15 years of age.

Maximum Bonus

20% of the salary or wages

Computation of Number of Working Days

For the purpose of Section 13, the employee shall be deemed to have worked if:-

The employee has been laid off


The employee has been on leave with pay
The employee has been absent due to accident while on duty
The employee has been on maternity leave.

Set on and Set off of Allocable Surplus

1. Where for any accounting year, the allocable surplus exceeds the amount of maximum
bonus payable to the employees the excess shall, subject to 20% of total salary and wages be
carried forward for being set on in the succeeding accounting year and so on upto and inclusive
of fourth accounting year to be utilized for the purpose of payment of bonus.
2. Where for any accounting year, there is no available surplus or allocable surplus in
respect of that year falls short of the amount of minimum bonus payable to the employees under
Section 10 and there is no sufficient amount carried forward, then such minimum amount shall
be carried forward for being set off in the succeeding year.

Special Provisions with respect to certain new Set up Establishment

The employees shall be entitled to be paid bonus.

In the first five years, the employer is liable to make payment of the bonus only during that
year/years in which there is profit.

For the Sixth Accounting Year- Set on and Set Off shall be made in the manner illustrated in the
fourth Shedule

For the Seventh Accounting year- Set on and set off, as the case may be, shall be made in the
manner illustrated in the fourth Shedule

From the eighth accounting the provisions of Section 15 shall apply.

Adjustment of Customary of Interim Bonus

Deductions of Certain amounts from Bonus The employee is found guilty of misconduct
causing financial loss, then it shall be lawful for the employer to recover this amount from the
bonus.

Time Limit

One month from the date of award

In other cases within eight month

Recovery of Bonus from an employer

In case of death of an employee the heirs or the person entitled shall receive bonus from the
employer.

Act to apply of certain pending dispute regarding payment of bonus.


Rep. by the Payment of Bonus (Amendment) Act, 1976 (23 of 1976), Section 21 (w.e.f. 25th
September, 1975).

Employees and employers not to be precluded from entering into agreements for grant of bonus
under a different formula. -

Nothing contained in this Act shall be construed to preclude employees employed in any
establishment or class of establishments from entering into agreements with their employer for
granting them an account of bonus under a formula which is different for that under this Act :

Provided that no such agreement shall have effect unless it is entered into with the previous
approval of the appropriate Government:

Provided further that any such agreement whereby the employees relinquish their right to receive
the minimum bonus under sub-section (2-A) of Section 10 shall be null and void in so far as it
purports to deprive them of such right:

Provided also that such employees shall not be entitled to be paid bonus in excess of -

(a) 8.33 per cent of the salary or wage earned by them during accounting year if the employer
has no allocable surplus in the accounting year or the amount of such allocable surplus is only so
much that, but for the provisions of sub-section (2-A)of Section 10, it would entitle the
employees only to receive an amount of bonus which is less than the aforesaid percentage, or (b)
Twenty per cent, of the salary or wage earned by them during the accounting year.

Employer and workmen enter into settlement before Conciliation Officer on 9th October, 1972
within the meaning of Sec.34 (3) of Payment of Bonus Act On a reference before the tribunal
workmen claims three month Salary as customers bonus or 2% of salary as per the Act
Validity of award directing payment of three months basic wages as on 31st March 1972 instead
of 31st March 1970 in term 1 of the Settlement. (Dishergarh Power Supply Co., Ltd. v. The
Workmen of Dishergarh Power Supply Co., Ltd., (1986) 3 SCJ 247).

Effect of laws and agreements inconsistent with the Act. -


Subject to the provisions of Sections 31-A and 34, the provisions of this Act shall have effect
notwithstanding anything inconsistent therewith contained in any other law for the time being in
force or in the terms of any award, agreement, settlement or contract of service.

Saving -

Nothing contained in this Act shall be deemed to affect the provisions of the Coal Mines
Provident Fund and Bonus Schemes Act, 1948 (46 of 1948), or of any scheme made there under.

Power of exemption -

If the appropriate Government, having regard to the financial position and other relevant
circumstances of any establishment or class of establishments, is of opinion that it will not be in
public interest to apply all or any of the provisions of this Act thereto, it may, by notification in
the official Gazette, exempt for such period as may be specified therein and subject to such
conditions as it may think fit to impose, such establishment or class of establishments from all or
any of the provisions of this Act.

Note

The Court has jurisdiction to consider whether the powers under Section 36 has been properly
exercised by the Government.

Consideration of the profits for one previous year cannot amount to consideration of the
financial position of an establishment within the terms of Section 36 of the Bonus Act. (M/s,
Fashan Electric Dry Cleaners v. The Government of A.P. (1977) 1 An. A.W.R.27).

Power to remove difficulties

Rep. by the Payment of Bonus (Amendment) Act, 1976 (23 of 1976), Section 23 (w.e.f. 25th
September, 1975).

Power of make rules. -

(1) The Central Government may make rules for the purpose of carrying into effect the provision
of this Act.
(2) In particular, and without prejudice to the generality of the foregoing power, such rules may
provide for -

(a) The authority for granting permission under the proviso to sub-clause (iii) of Cl. (I) of Sec.2 ;

(b) The preparation of registers, records and other document and the form and manner in which
such registers, records and documents may be maintained under Sec.26 ;

(c) The powers which may be exercised by an inspector under Cl. (e) of sub-section (2) of Sec.27

(d) Any other matter which is to be, or may be prescribed.

(3) Every rule made under this section shall be laid as soon as may be after it is made, before
each House of Parliament while it is in session for a total period of thirty days, which may be
comprised in one session [(Note: Subs. by Act 23 of 1976, (w.e.f. 25th September, 1975) or in
two or more successive session], and if before the expiry of the session [(Note: Subs. by Sec.21,
ibid, (w.e.f. 25th September, 1975) immediately following the session or the successive sessions
aforesaid], both Houses agree in making any modification in the rule or both Houses agree that
the rule should not be made, the rule shall thereafter have effect only in such modified form or be
of no effect as the case may be; so however, that any such modification or annulment shall be
without prejudice to the validity of anything previously done under that rule.

Application of certain laws not barred. -

Save as otherwise expressly provided, the provisions of this Act shall be in addition to and not in
derogation of the industrial Disputes Act, 1947 (14 of 1947) or any corresponding law relating
The Orient Tavern investigation and settlement of industrial disputes in force in a State.

Repeal and saving -

(1) The Payment of Bonus Ordinance, 1965 (3 of 1965) is hereby repealed.

(2) Notwithstanding such repeal, anything done or any action taken under the said Ordinance
shall be deemed to have been done or taken under this Act as if this Act commenced on the 29th
May, 1965.

Benefits Under The Act


Subject to provisions: minimum bonus shall be 8.33% of the salary/wages earned by the
employees or Rs. 100 whichever is higher.

If allocable surplus, as computed under the Act, exceeds the amount of minimum bonus, then
bonus shall be payable at rate subject to a maximum 20% of salary/wages earned during the
accounting year.

Other important issues

Computation of Bonus is to be worked out as per Schedules I to IV of the Act.

Records in Form No. A, B & C are to be maintained.

Annual Return in Form D is required to be filed.

Time limit for payment of Bonus is prescribed as within 8 (eight) months from the closing of
Accounting year if there is no dispute. In the case of dispute in respect of Bonus pending before
any authority, bonus must be paid within 30 days from the date on which such award becomes
enforceable or the date of settlement.
CHAPTER 9
The Payment of Gratuity Act,1972

1. Short title and commencement.-(1) These rules may be called the Payment of Gratuity
(Central) Rules, 1972.

(2) These rules shall come into force on the 16th September, 1972;

2. Definitions.-In these rules, unless there is anything repugnant in the subject or context,-

(a) "Act" means the Payment of Gratuity Act, 1972 (39 of 1972);

(b) "Appellate authority" means the Central Government or the authority specified by the
Central Government under sub-section (7) of section 7;

(c) "Form" means a form appended to these rules;

(d) "nomination" means nomination made under section 6;

(e) "section" means a section of the Act.

3. Notice of opening, change or closure of the establishment.- (1) Within thirty days of the
rules becoming applicable to an establishment, a notice in Form A shall be submitted by the
employer to the controlling authority of the area.

(2) A notice in Form B shall be submitted by the employer to the controlling authority of the
area within thirty days of any change in the name, address, employer or nature of business.

(3) Where an employer intends to close down the business he shall submit a notice in Form C
to the controlling authority of the area at least sixty days before the intended closure.

4. Display of notice.-(1) The employer shall display conspicuously a notice at or near the
main entrance of the establishment in bold letters in English and in a language understood by the
majority of the employees specifying the name of officer with designation authorised by the
employer to receive on his behalf notices under the Act or the rules.
(2) A fresh notice shall be displayed immediately after the notice referred to in sub-rule (1)
becomes illegible or requires a change.

*5. Form of notice under proviso to section (2) (h) (ii).-(1) A notice under the proviso to sub-
clause (ii) of clause (h) of section 2 shall be in Form D and sent in triplicate by the employee to
the employer, who shall, after recording its receipt on one copy thereof, return the copy to the
employee and send the second copy to the controlling authority of the area

1. Vide G,S.R. 412 (E). dated 16th September, 1972, published in the Gazette of India;
Extra., Pt. II, Sec. 3(i), dated 16th September, 1972.

* By section 2 of the Payment of Gratuity (Amendment) Act, 1987 (22 of 1987)


proviso to sub- clause (ii) of clause (h) of section 2 of the Payment of Gratuity Act,
1972 (39 of 1972) has been omitted (w.e.f. 1-10-1987) and accordingly rule 5 along
with Forms D and E have become redundant, Ed.

(2) An employee may withdraw the notice referred to in sub-rule (1) by giving another notice in
triplicate in Form 'E' to the employer, who shall follow the same procedure as in sub-rule (1).

6. Nominations.-(1) A nomination shall be in Form 'F' and submitted in duplicate by personal


service by the employee, after taking proper receipt or by sending through registered post
acknowledgement due to the employer,

(i) in the case of an employee who is already in employment for a year or more on the date
of commencement of these rules, ordinarily, within ninety days from such date, and

(ii) in the case of an employee who completes one year of service after the date of
commencement of these rules, ordinarily within thirty days of the completion of one year of
service:

Provided that nomination in Form 'F' shall be accepted by the employer after the specified
period, if filed with reasonable grounds for delay, and no nomination so accepted shall be invalid
merely because it was filed after the specified period.
(2) Within thirty days of the receipt of nomination in Form 'F' under sub-rule (1), the
employer shall get the service particulars of the employee, as mentioned in the form of
nomination, verified with reference to the records of the establishment and return to the
employee, after obtaining a receipt thereof, the duplicate copy of the nomination in form 'F' duly
attested either by the employer or an officer authorised in this behalf by him, as a token of
recording of the nomination by the employer and the other copy of the nomination shall be
recorded.

(3) An employee who has no family at the time of making a nomination shall, within ninety
days of acquiring a family submit in the manner specified in sub-rule (1), a fresh nomination, as
required under sub-section (4) of section 6, duplicate in Form 'G' to the employer and thereafter
the provisions of sub-rule (2) shall apply mutatis mutandis as if it was made under sub-rule (1).

(4) A notice of modification of a nomination, including cases where a nominee predeceases an


employee, shall be submitted in duplicate in Form 'H' to the employer in the manner specified in
sub-rule (1), and thereafter the provisions of sub-rule (2) shall apply mutatis mutandis.

(5) A nomination or a fresh nomination or a notice of modification of nomination shall be


signed by the employee or, if illiterate, shall bear his thumb impression, in the presence of two
witnesses, who shall also sign a declaration to that effect in the nomination, fresh nomination or
notice of modification of nomination, as the case may be.

(6) A nomination, fresh nomination or notice of modification of nomination shall take effect
from the date of receipt thereof by the employer.

7. Application for gratuity.-(1) An employee who is eligible for payment of gratuity under the
Act, or any person authorised, in writing, to act on his behalf, shall apply, ordinarily within thirty
days from the date the gratuity became payable, in Form 'I' to the employer:

Provided that where the date of superannuation or retirement of an employee is known, the
employee may apply to the employer before thirty days of the date of superannuation or
retirement.
(2) A nominee of an employee who is eligible for payment of gratuity under the second proviso
to sub-section (1) of section 4 shall apply, ordinarily within thirty days from the date of gratuity
became payable to him, in Form J to the employer:

Provided that an application in plain paper with relevant particulars shall also be accepted.
The employer may obtain such other particulars as may be deemed necessary by him.

(3) A legal heir of an employee who is eligible for payment of gratuity under the second
proviso to sub-section (1) of section 4 shall apply, ordinarily within one year from the date of
gratuity became payable to him, in Form 'K' to the employer.

(4) Where gratuity becomes payable under the Act before the commencement of these rules,
the periods of limitation specified in sub-rules (1), (2) and (3) shall be deemed to be operative
from the date of such commencement.

(5) An application for payment of gratuity filed after the expiry of the periods specified in this
rule shall also be entertained by the employer, if the applicant adduces sufficient cause for the
delay in preferring his claim, and no claim for gratuity under the Act shall be invalid merely
because the claimant failed to present his application within the specified period. Any dispute in
this regard shall be referred to the controlling authority for his decision.

(6) An application under this rule shall be presented to the employer either by personal
service or by registered post acknowledgement due.

8. Notice for payment of gratuity.-(1) Within fifteen days of the receipt of an application
under rule 7 for payment of gratuity, the employer shall-

(i) if the claim is found admissible on verification, issue a notice in Form 'L to the applicant
employee, nominee or legal heir, as the case may be, specifying the amount of gratuity payable
and fixing a date, not being later than the thirtieth day after the date of receipt of the application,
for payment thereof, or

(ii) if the claim for gratuity is not found admissible, issue a notice in Form 'M' to the
applicant employee, nominee or legal heir, as the case may be, specifying the reasons why the
claim for gratuity is not considered admissible. In either case a copy of the notice shall be
endorsed to the controlling authority.

(2) In case payment of gratuity is due to be made in the employer's office, the date fixed for
the purpose in the notice in Form 'L' under clause (1) of sub-rule (1) shall be refiexed by the
employer, if a written application in this behalf is made by the payee explaining why it is not
possible for him to be present in person on the date specified.

(3) If the claimant for gratuity is a nominee or a legal heir, the employer may ask for such
witness or evidence as may be deemed relevant for establishing his identity or maintainability of
his claim, as the case may be. In that 'case, the time limit specified for issuance of notices under
sub-rule (1) shall be operative with effect from the date such witness or evidence, as the case
may be, called for by the employer is furnished to the employer.

(4) A notice in Form 'L' or Form 'M' shall be served on the applicant either by personal
service after taking receipt or by registered post with acknowledgement due.

(5) A notice under sub-section (2) of section 7 shall in Form L.

9. Mode of payment of gratuity.- The gratuity payable under the Act shall be paid in cash or, if
so desired by the payee, in Demand Draft or bank Cheque to the eligible employee, nominee or
legal heir, as the case may be

Provided that in case the eligible employee, nominee or legal heir, as the case may be, so
desires and the amount of gratuity payable is less than one thousand rupees, payment may be
made by postal money order after deducting the postal money order commission therefor from
the amount payable:

Provided further that intimation about the details of payment shall also be given by the
employer to the controlling authority of the area:

1[Provided further that in the case of nominee, or an heir, who is minor, the controlling
authority shall invest the gratuity amount deposited with him for the benefit of such minor in
term deposit with the State Bank of India or any of its subsidiaries or any Nationalised Bank.
Explanation.-"Nationalised Bank" means a corresponding new bank specified in the First
Schedule to the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 (5 of
1970) or a corresponding new bank specified in the First Schedule of the Banking Companies
(Acquisition and Transfer of Undertakings) Act,. 1980 (40 of 1980).]

10. Application to controlling authority for direction.-(1) If an employer-

(i) refuses to accept a nomination or to entertain an application sought to be filed under rule
7, or

(ii) issues a notice under sub-rule (1) of rule 8 either specifying an amount of gratuity which
is considered by the applicant less than what is payable or rejecting eligibility to payment of
gratuity, or

(iii) having received an application under rule 7 fails to issue any notice as required under rule
8 within the time specified therein,

the claimant employee, nominee or legal heir, as the case may be, may, within ninety days of the
occurrence of the cause for the application, apply in Form 'N' to the controlling authority for
issuing a direction under sub-section (4) of section 7 with as many extra copies as are the
opposite party:

Provided that the controlling authority may accept any application under this sub-rule, on
sufficient cause being shown by the applicant, after the expiry of the specified period.

(2) Application under sub-rule (1) and other documents relevant to such an application shall
be presented in person to the controlling authority or shall be sent by registered post
acknowledgement due.

11. Procedure for dealing with application for direction.-(1) On receipt of an application
under rule 10 the controlling authority shall, by issuing a notice in Form 'O', call upon the
applicant as well as the employer to appear before him on a specified date, time and place, either
by himself or through his authorised representative together with all relevant documents and
witnesses, if any.
(2) Any person desiring to act on behalf of an employer or employee, nominee or legal heir, as
the cases may be, shall present to the controlling authority a letter of authority from the employer
or the person concerned, as the case may be, on whose behalf he seeks to act together with a
written statement explaining his interest in the matter and praying for permission so to act. The
controlling authority shall record thereon an order either according his approval or specifying, in
the case of refusal to grant the permission prayed for, the reasons for the refusal.

(3) A party appearing by an authorised representative shall be bound by the acts of the
representative.

(4) After completion of hearing on the date fixed under sub-rule (1), or after such further
evidence, examination of documents, witnesses, hearing and enquiry, as may be deemed
necessary, the controlling authority shall record his finding as to whether any amount is payable
to the applicant under the Act. A copy of the finding shall be given to each of the parties.

(5) If the employer concerned fails to appear on the specified date of hearing after due
service of notice without sufficient cause, the controlling authority may proceed to hear and
determine the application ex parte. If the applicant fails to appear on the specified date of hearing
without sufficient cause, the controlling authority may dismiss the application:

Provided that an order under this sub-rule may, on good cause being shown within thirty
days of the said order, be reviewed and the application re-heard after giving not less than
fourteen days' notice to the opposite party of the date fixed for rehearing of the application.

12. Place and time of hearing.- The sittings of the controlling authority shall be held at such
times and at such places as he may fix and he shall inform the parties of the same in such manner
as he thinks fit.

13. Administration of oath.- The controlling authority may authorise a clerk of his office to
administer oaths for the purpose of making affidavits.

14. Summoning and attendance of witnesses.- The controlling authority may, at any stage of
the proceedings before him, either upon or without an application by any of the parties involved
in the proceedings before him, and on such terms as may appear to the controlling authority just,
issue summons to any person in Form 'P' either to give evidence or to produce documents or for
both purposes on a specified date, time and place.

15. Service of summons or notice.-(1) Subject to the provisions of sub-rule (2) any notice,
summons, process or order issued by the controlling authority may be served either personally or
by registered post acknowledgement due or in any other manner as prescribed under the Code of
Civil Procedure, 1908 (Act 5 of 1908)

(2) Where there are numerous persons as parties to any proceeding before the controlling
authority and such persons are members of any trade union or association or are represented by
an authorised person, the service of notice on the Secretary, or where there is no Secretary, on
the principal officer of the trade union or association, or on the authorised person shall be
deemed to be service on such persons

16. Maintenance of records of cases by the controlling authority.-(1) The controlling authority
shall record the particulars of each case under section 7, in Form 'Q' and at the time of passing
orders shall sign and date the particulars so recorded.

(2) The controlling authority shall, while passing orders in each case, also record the
findings on the merits of the case and file it together with the memoranda of evidence with the
order sheet.

(3) Any record, other than a record of any order or direction, which is required by these rules
to be signed by the controlling authority, may be signed on behalf of and under the direction of
the controlling authority by any subordinate officer appointed in writing for this purpose by the
controlling authority.

17. Direction for payment of gratuity.-If a finding is recorded under sub-rule (4) of rule 11
that the applicant is entitled to payment of gratuity under the Act, the controlling authority shall
issue a notice to the employer concerned in Form 'R' specifying the amount payable and directing
payment thereof to the applicant under intimation to the controlling authority within thirty days
from the date of the receipt of the notice by the employer. A copy of the notice shall be endorsed
to the applicant employee, nominee or legal heir, as the case may be.
18. Appeal.-(1) The Memorandum of appeal under sub-section (7) of section 7 of the Act shall
be submitted to the appellate authority with a copy thereof to the opposite party and the
controlling authority either through delivery in person or under registered post acknowledgement
due.

(2) The Memorandum of appeal shall contain the facts of the case, the decision of the
controlling authority, the grounds of appeal and the relief sought.

(3) There shall be appended to the Memorandum of appeal a certified copy of the finding of
the controlling authority and direction for payment of gratuity.

(4) On receipt of the copy of Memorandum of appeal, the controlling authority shall forward
records of the case to the appellate authority.

(5) Within 14 days of the receipt of the copy of the Memorandum of appeal, the opposite
party shall submit his comments of each paragraph of the memorandum with additional pleas, if
any, to the appellate authority with a copy to the appellant.

(6) The appellate authority shall record its decision after giving the parties to the appeal a
reasonable opportunity of being heard. A copy of the decision shall be given to the parties to the
appeal and a copy thereof shall be sent to the controlling authority returning his records of the
case.

(7) The controlling authority shall, on receipt of the decision of the appellate authority, make
necessary entry in the records of the case maintained in Form 'Q' under sub-rule (1) of rule 16.

(8) On receipt of the decision of the appellate authority, the controlling authority shall, if
required under that decision, modify his direction for payment of gratuity and issue a notice to
the employer concerned in Form 'S' specifying the modified amount payable and directing
payment thereof to the applicant, under intimation to the controlling authority within fifteen days
of the receipt of the notice by the employer. A copy of the notice be endorsed to the appellant
employee, nominee or legal heir, as the case may be and to the appellate authority.

19. Application for recovery of gratuity.-Where an employer fails to pay the gratuity due under
the Act in accordance with the notice by the controlling authority under rule 17 or rule 18, as the
case may be, the employee concerned, his nominee or legal heir, as the case may be, to whom the
gratuity is payable may apply to the controlling authority in duplicate in Form 'T' for recovery
thereof under section 8 of the Act.

20. Display of abstract of the Act and Rules.- The employer shall display an abstract of the Act
and the rules made thereunder 1[as given in Form 'U'] in English and in the language understood
by the majority of the employees at conspicuous place at or near the main entrance of the
establishment.

Nomination.-(1) Each employee, who has completed one year of service, after the
commencement of the Payment of Gratuity (Central) Rules, 1972, shall make within thirty days
of completion of one year of service, a nomination [Section 6(1) read with Rule 8, 6(1)].

(2) If an employee has a family at the time of making a nomination the nomination shall be
made in favour of one or more members of his family and any nomination made by such
employee in favour of a person who is not member of his family shall be void. [Section 6(3)].

(3) If at the time of making a nomination, the employee has no family, the nomination can be
made in favour of any person or persons, but if the employee subsequently acquires a family,
such nomination shall forthwith become invalid and the employee shall make within 90 days a
fresh nomination in favour of one or more members of this family. [section 6(4) read with rule
6(3)].

(4) A nomination or a fresh nomination or a notice of modification of nomination shall be


signed by the employee or, if illiterate, shall bear his thumb impression in the presence of two
witnesses, who shall also sign declaration to that effect in that nomination, fresh nomination or
notice of modification of nomination as the case may be. [Rule 6(5)].

(5) A nomination may, subject to the provisions of sub-sections (3) and (4) of section 6 be
modified by an employee any time after giving to his employer a written notice of his intention
to do so.[Section 6(5)].

(6) A nomination or fresh nomination or notice of modification of nomination shall take


effect from the date of receipt of the same by the employer. [Rule 6(6)].
Application for gratuity.-(1) An employee who is eligible for payment of gratuity under the Act,
or any person authorised, in writing, to act on his behalf, shall apply ordinarily within thirty days
from the date of gratuity became payable:

Provided that where the date of superannuation or retirement of an employee is known, the
employee may apply to the employer before thirty days of the date of superannuation or
retirement. [Rule 7(1)].

(2) A nominee of an employee who is eligible for payment of gratuity shall apply, ordinarily
within thirty days from the date the gratuity became payable to him, to the employer. [Rule 7(2)].

(3) A legal heir of an employee who is eligible for payment of gratuity shall apply, ordinarily
within one year from the date the gratuity became payable to him, to the employer. [Rule 7(3)].

(4) An application for payment of gratuity filed after the expiry of the periods specified above
shall also be entertained by the employer if the applicant adduces a sufficient cause for the delay.
[Rule 7(5)].

Payment of gratuity.-(1) Gratuity shall be payable to an employee on the termination of his


employment after he has rendered continuous service for not less than five years-

(a) on his superannuation, or

(b) on his retirement or registration, or

(c) on his death or disablement due to accident or disease:

Provided that the completion of continuous service of five years shall not be necessary where
the termination of the employment of any employee is due to death or disablement:

Provided further that in case of death of the employee, gratuity payable to him shall be paid to
his nominee or, if no nomination has been made, to his heirs, and where any such nominees or
heirs is a minor the shares of such minor, shall be deposited with the controlling authority who
shall invest the same for the benefit of such minor in such bank or other financial institution, as
may be prescribed, until such minor attains majority.

Disablement means such disablement which incapacitates an employee for the work which
he was capable of performing before the accident or disease resulting in such disablement.
[Section 4(1)].

(2) For every completed year of service or part thereof in excess of six months, the employer
shall pay gratuity to an employee at the rate of fifteen days' wages based on the rate of wages last
drawn by the employee concerned:

Provided that in the case of a piece-rated employee, daily wages shall be computed on the
average of the total wages received by him for a period of three months immediately preceding
the termination of his employment, and, for this purpose, the wages paid for any overtime work
shall not be taken into account:

Provided further that in the case of an employee employed in seasonal establishment, the
employer shall pay the gratuity at the rate of seven days' wages for each season. [Section 4(2)].

Explanation.-In case of a monthly rated employee, the fifteen days' wages shall be calculated
by dividing the monthly rate of wages last drawn by him by twenty-six and multiplying quotient
by fifteen.

(3) The amount of gratuity payable to an employee shall not exceed twenty months
wages.[Section 4(3)].

Forfeiture of gratuity,-(1) The gratuity of an employee, whose services have been terminated for
any act, willful omission or negligence causing any damage or loss to, or destruction of, property
belonging to the employer, shall be forfeited to the extent of the damage or loss so caused;

(2) The gratuity payable to an employee shall be wholly forfeited-

(a) If the services of such employee have been terminated for his riotous or disorderly
conduct or any other act of violence on his part, or
(b) If the services of such employee have been terminated for any act which constitutes an
offence involving moral turpitude, provided that such offence is committed by him in the course
of his employment.[Section 4(6)].

Administrative Machinery

All the Assistant Labour Commissioners and Labour Officers in the Labour Department have
been appointed Controlling Authority and all the Deputy Labour Commissioners have been
appointed Appellate Authority under the Act.

Responsibility of The Employeers

It is the duty of the employer to determine the amount of gratuity as soon as it becomes payable
and to give notice of the same to the person to whom gratuity is payable and also to the
Controlling Authority. The employer shall also provide to pay the amount of gratuity to the
person to whom it is payable. Failure to do so shall render him liable to pay the interest at the
prevailing rate from time taken. In case the employee is not paid the due amount of gratuity he
should apply, ordinarily within thirty days, in Form-I to the employer. Is an employer fails to pay
due gratuity even after the receipt of notice in Form-1, the claimant employee or his nominee or
legal heir, may within ninety days of the occurrence of the case for the application, should apply
in Form-IV, to the Controlling Authority for issuing direction to the employer. After conducting
the enquiry as prescribed, the Controlling Authority will determine the amount payable and
direct the employer to make the payment. If the employer fails to comply with the direction the
Controlling Authority can direct the Collector to recover the amount due and pay to the
applicant.

Penalty

The Act provides that whoever makes false statement for the purpose of avoiding any payment
shall be punishable with imprisonment for a term which may extend to six months or with fine
which may extend to ten thousand rupees or with both. An employer who contravenes any
provisions of the Act shall be liable for imprisonment for a term of not less than three months but
which may extend to one year or with fine which shall not be less than ten thousand rupees but
which may extend to twenty thousand rupees or with both. Where the offence relates to non-
payment of gratuity the employer can be punished with imprisonment for a term which is not less
than six months.
CHAPTER 10
Wage Determination
Chapter Overview
Building on the resource demand analysis of the previous chapter, this chapter provides a
detailed supply and demand analysis of wage determination in a variety of possible labor market
structures. Though the analysis may seem rigorous, it is little more than an application of supply
and demand tools.

A discussion of the general level of real wages opens the chapter. The critical link between labor
productivity and real wages merits emphasis as a theoretical and policy issue.

The section on wage determination in particular labor markets is the heart of the chapter.
Competitive, monopsonistic, unionized, and bilateral monopoly market models are examined.
Discussion of the effectiveness of unions in raising wages, and the complex issue of minimum
wage laws follow.

Wage differentials are explained by the differences among worker characteristics, job
characteristics, and lack of worker mobility. The chapter concludes with a discussion of pay
schemes that link earnings to worker performance, their contributions to efficiency, and possible
negative side effects.

Lecture Notes

A. Wages refer to the price paid for the use of labor.

1. Labor may be workers in the popular sense of the terms blue-collar and white-collar
workers.

2. Labor also refers to professional people and owners of small businesses, in terms of the
labor services they provide in operating their businesses.

B. Wages may take the form of bonuses, royalties, commissions, and salaries, but in this text
the term wages is used to mean wage rate or price paid per unit of labor time.

C. It is important to distinguish between nominal and real wages.


1. Nominal wages are the amount of money received per hour, per day, per week and so on.

2. Real wages are the purchasing power of the wage, i.e., the quantity of goods and services
that can be obtained with the wage. Ones real wages depend not only on ones nominal wage
but also on the price level of the goods and services that will be purchased.

3. Example: If nominal wages rise by 10 percent and there is a 5 percent rate of inflation,
then the real wage rose only by 5 percent.

4. In this discussion, it is assumed that the price level is constant, and so the term wages is
used in the sense of real wages.

The general level of wages differs greatly among nations, regions, occupations, and individuals.

A. Productivity plays an important role in determination of wages. Historically, American


wages have been high and have risen because of high productivity. There are several reasons for
this high productivity.

1. Capital equipment per worker is highapproximately $90,000 per worker.

2. Natural resources have been abundant relative to the labor force in the United States.

3. Technological advances have been generally higher in the U.S. than in most other
nations, and work methods are steadily improving.

4. The quality of American labor has been high because of good education, health and work
attitudes.

5. There are other, less tangible items underlying the high productivity of American
workers.

a. Efficient, flexible management.

b. Stable business, social and political environment, conducive to growth.

c. Vast size of the domestic market, which allows for economies of scale.

d. Increased specialization of global production facilitated by free-trade agreements.


B. Real wages and productivity: real hourly compensation per worker can increase only at
about the same rate as output per worker.

C. There has been a long term, secular growth pattern in real wages.

Economic Models of the Labor Market

A. The competitive labor market model.

1. Characteristics of a competitive labor market include:

a. Numerous firms competing to hire a specific type of labor,

b. Many qualified workers with identical skills available to independently supply this type
of labor service, and

c. Wage taker behavior that pertains to both employer and employee; neither can control
the market wage rate.

2. The market demand is determined by summing horizontally the labor demand curves

3. The market supply will be determined by the amount of labor offered at different wage
rates; more will be supplied at higher wages because the wage must cover the opportunity costs
of alternative uses of time spent either in other labor markets or in household activities or leisure.

4. The market equilibrium wage and quantity of labor employed will be where the labor
demand and supply curves intersect; in Figure 13.3a this occurs at a $10 wage and 1,000
employed.

a. Each individual firm will take this wage rate as given, and will hire workers up to the
point at which the market wage rate is equal to the MRP of the last worker hired (according to
the MRP = MRC rule). Note that the demand curve in Figure 13.3 is based on figures from
Table 12.1 in the last chapter.

b. For each firm, the MRC is constant and equal to the wage because the firm is a wage
taker and by itself has no influence on the wage in the competitive model.

B. In the monopsony model, the firms hiring decisions have an impact on the wage.
1. Characteristics of the monopsony model:

a. The firms employment is a large portion of the total employment of a particular kind of
labor.

b. The type of labor is relatively immobile, either geographically or in the sense that to find
alternative employment workers must acquire new skills.

c. The firm is a wage maker in the sense that the wage rate the firm pays varies directly
with the number of workers it employs.

2. Complete monopsonistic power exists when there is only one major employer in a labor
market; oligopsony exists when there are only a few major employers in a labor market. (Note:
the root sony means to purchase, whereas the root poly means to sell.)

a. The labor supply curve will be upward sloping for the monopsonistic firm; if the firm is
large relative to the market, it will have to pay a higher wage rate to attract more labor.

b. As a result, the marginal resource cost will exceed the wage rate in monopsony because
the higher wage paid to additional workers will have to be paid to all similar workers employed.
Therefore, the MRC is the wage rate of an added worker plus the increments that will have to be
paid to others already employed.

c. Equilibrium in the monopsonistic labor market will also occur where MRC = MRP, but
now the MRC is above the wage, so the wage will be lower than it would be if the market were
competitive. As a result, the monopsonistic firm will hire fewer workers than under competitive
conditions.

d. Conclusion: In a monopsonistic labor market there will be fewer workers hired and at a
lower wage than would be the case if that same labor market were competitive, other things
being equal.

e. Illustrations: Nurses are paid less in towns with fewer hospitals than in towns with more
hospitals. In professional athletics, players salaries are held down as a result of the player
drafts that prevent teams from competing for the new players services for several years until
they become free agents.
C. The (Three) Union models illustrate a different set of models of imperfect competition in
the labor market where the workers are organized so that employers do not deal directly with the
individual workers, but with their unions, who try to raise wage rates in several ways. There are
three models of these methods.

1. Demand Enhancement Model Unions prefer to raise wages by increasing the demand
for labor.

a. Unions may try to increase the price of substitutes resources, thus increasing the demand
for union workers, e.g., higher minimum wages.

d. Unions can increase the demand for their labor by supporting public actions that reduce
the price of a complementary resource, e.g., utility prices.

2. Exclusive or craft unions raise wages by restricting the supply of workers, either by large
membership fees, long apprenticeships, or forcing employers to hire only union workers. (Figure
13.6)

3. Occupational licensing requirements are another way of restricting labor supply in order
to keep wages high. Six hundred occupations are licensed in the U.S.

4. Inclusive or industrial unions do not limit membership but try (usually unsuccessfully) to
unionize every worker in a certain industry so that they have the power to impose a higher wage
than the employers would otherwise pay

The bargained wage becomes the MRC for the employer between point a and point e.

5. Employers will hire fewer workers than they would if the workers were free to accept a
lower wage.

a. Studies indicate that the size of the union advantage is between 10 and 15 percent.

. b. The size of the unemployment effect will depend on certain factors.

1. Growth in the economyIf demand is increasing, then this shift in labor demand can
offset the unemployment effect of the union wage increase.
2. If the demand for the product and/or labor is inelastic, the wage increase will not have as
much effect on employment as it would if the demand were elastic.

D. Bilateral monopoly model occurs when a monopsonist employer faces a unionized labor
force; in other words, both the employer and employees have monopoly power.

1. In such a model, the outcome of the wage is indeterminate and will depend on negotiation (see
Figure 13.8) and bargaining power.

2. A bilateral monopoly may be more desirable than one sided market power. In other words, if
a competitive market does not exist, it may be more socially desirable to have power on both
sides of the labor market, so that neither side exploits the other. This can be shown by
comparing Qu = Qm, and Qc.

V. The minimum wage controversy concerns the effectiveness of minimum wage legislation
as an antipoverty device. (Figure 13.7 and Figure 13.8 can be used by substituting the minimum
wage for the bargained wage.)

A. Facts about the minimum wage:

1. The Federal minimum wage was implemented with the Fair Labor Standards Act in 1938.

2. The Federal minimum wage has ranged between 30 and 50 percent of the average wage paid
to manufacturing workers in 2007.

3. Sixteen states have minimum wages exceeding the Federal minimum wage. In 2006, the state
of Washington had the highest at $7.63 an hour.

B. The case against the minimum wage contains two major criticisms.

1. The minimum wage forces employers to pay a higher than equilibrium wage, so they will hire
fewer workers as the wage pushes them higher up their MRP curve.

2. The minimum wage is not an effective tool to fight poverty. Some minimum wage workers
are teens or are from affluent families who do not need protection from poverty.

C. The case for the minimum wage argues includes other arguments.
1. Minimum-wage laws occur in markets that are not competitive and not static. In a
monopolistic market, the minimum wage increases wages with minimal effects on employment.

2. Increasing minimum wage may increase productivity.

a. Managers will use workers more efficiently when they have higher wages.

b. The minimum wage may reduce labor turnover and thus training costs.

D. Evidence and conclusions

1. During the 1980s, some unemployment resulted from the minimum wage, especially among
teens, but the effect of increases during the 1990s were inconclusive.

2. Because many who are affected by the minimum wage are not from poverty families, an
increase in the minimum wage is not as strong an antipoverty tool as many supports contend.

3. More workers are helped by the minimum wage than are hurt.

4. The minimum wage helps give some assurance that employers are not taking advantage of
their workers.

VI. Wage Differentials

A. Table 13.3 gives a selection of wages in different occupations to illustrate the substantial
differences among them.

B. Wage differentials can be explained by using supply and demand for various occupations.

1. Given the same supply conditions, workers for whom there is a strong demand
will receive higher wages; given the same demand conditions, workers where there is a reduced
supply will receive higher wages.

2. The workers contribution to the employers total revenue (MRP) will depend
upon the workers productivity and the demand for the final product.

3. On the supply side, workers are not homogeneous, i.e., they are in noncompeting
groups. These differences that determine these noncompeting groups are:
a. Ability levels differ among workers.

b. Education and training, i.e. investment in human capital.

i. Human capital is the accumulated knowledge, know-how, skills,


experience, and health that enable a person to be productive and generate income.

ii. Figure 26.10 indicates that those with more years of schooling achieve higher
incomes.

iii. The pay gap between college graduates and high school graduates increased
substantially between 1980 and 2003.

4. Workers also will experience wage differentials partly due to compensating


differences among jobs. These are the nonmonetary aspects of the job that may make some
jobs preferable to others because of working conditions, location, etc.

C. Since market imperfections exist, labor markets are not perfectly competitive.

1. Workers may lack information about alternative job opportunities.

2. Workers may be reluctant to move to other geographic locations.

3. Artificial restraints on mobility may be created by unions, professional organizations, and


the government.

4. Discrimination in certain labor markets may crowd women and minorities into certain
labor markets and out of others. This is referred to as occupational segregation.

VII. Pay and performance are linked in many jobs, unlike the standardized wage rate per time
unit.

A. When one considers workers as the firms agents and the firm as the principal, the
principal agent problem emerges.

1. Both the workers and the firm want the firm to survive and be profitable.
2. If the agents do not perceive that the workers and firms interests are identical, there may
be a problem, because workers will act to improve their own well being, often at the expense of
the firm Some examples include loafing on the job, using company materials, and generally not
working as hard as they might.

3. Some incentive methods of payment help to avoid the principal agent problem.

a. With piece rate payments, workers earn according to the quantity of output produced.

b. Commissions and royalties are payment schemes linked to the value of sales.

c. Bonuses, stock options, and profit sharing are other ways to motivate workers to have the
same interests as the firm.

d. Efficiency wages are a way of providing incentives by paying workers above equilibrium
wages to encourage extra effort.

B. Pay for performance can help overcome the principal-agent problem and enhance worker
productivity, but such plans can have negative side effects.

1. A rapid production pace can compromise quality and endanger workers.

2. Commissions may cause salespeople to exaggerate claims, suppress information, and use
other fraudulent sales practices.

3. Bonuses based on personal performance may disrupt cooperation among workers.

4. Less energetic workers can take a free ride in profit sharing firms.

5. Firms paying efficiency wages may have fewer opportunities to hire the new workers
who could energize the workplace.

Last Word: Are Chief Executive Officers (CEOs) Overpaid?

A. Multimillion dollar salaries of top corporate executives are highly criticized.


B. CEO pay in the U.S. ($2.2 million average for firms with $500 million in sales) in 2005
was almost twice that of France and Germany ($1.2 million), and at least three times that of
South Korea and Japan.

C. Supporters of high CEO compensation argue that executive decisions affect the
productivity of all employees in a firm. This, in turn, affects profitability for firms, and the
difference between a good and a poor decision can be millions (if not billions) of dollars.

D. Some economists argue that CEO pay is analogous to the top pay received by top
performers in athletics (golf and tennis tournaments) and the entertainment industry. By having
these substantial rewards for the winners, it promotes greater productivity both for those
holding CEO positions, and for those aspiring to be CEOs.

E. Critics contend that although CEOs deserve higher pay than ordinary workers, the gaps
are excessive (they would especially balk at CEO performance bonuses at times of wage and
salary freezes or cuts for ordinary workers). They also believe that the high salaries are unfair to
stockholders. Boards of Directors exaggerate the importance of the CEO and thus
overcompensate, reducing company profits and potential dividends for investors.

Labor Unions and Their Impacts

I. Unionism in America

A. About 12.1 percent (15.7 million) U.S. workers belonged to unions in 2007.

1. Many unions (representing 8 million workers) are voluntarily affiliated with the
American Federation of Labor and Congress of Industrial Organizations (AFL-CIO).

2. There are a number of independent unions, representing 6 million workers,


including organizations such as the Teamsters, Service Employees Union, and Nurses Union.

B. In the United States, unions have generally adhered to a philosophy of business unionism.

1. Concerned with the practical short-run economic objectives of higher pay, shorter hours,
and improved working conditions.

2. Union members have not organized into a distinct political party.


C. The likelihood of union membership depends mainly on the industry: Membership is
high in government, education, protective services, transportation, construction, manufacturing
and mining; low in agriculture, finance, services (food and sales workers), wholesale and retail
trade. (See Figures 1a and b)

D. The decline of unionism.

1. Since the mid-1950s union membership has not kept pace with the growth of the labor
force. Union membership has declined both absolutely and relatively.

2. The structural-change hypothesis says that changes unfavorable to union membership


have occurred in both the economy and the labor force.

a. Employment patterns have shifted away from unionized industries. Consumer demand
has shifted from unionized U.S. producers of manufactured goods to foreign producers. Also
demand has shifted from highly organized old-economy unionized firms to high-tech
industries.

b. A higher proportion of the increase in employment recently has been concentrated among
women, youths and part time workers; groups that harder to organize.

c. A geographic shift of industrial location away from the northeast and Midwest
(traditional union country) to the south and southwest.

d. Union success in gaining higher wages for their workers may have given employers an
incentive to substitute away from the expensive union labor in a number of ways.

i. Substituting machinery for workers,

ii. Subcontracting more work to nonunion suppliers,

iii. Opening nonunion plants in less industrialized areas, and

iv. Shifting production of components to low-wage nations.

E. Relatively high-priced union produced goods would encourage consumers to seek lower-
cost goods produced by non-union workers.
II. Collective Bargaining

A. The goal of collective bargaining is to establish a work agreement between the firm and
the union.

B. Union status and managerial prerogatives.

1. In a closed shop, a worker must be (or become) a member of the union before being
hired. This is illegal except in transportation and construction.

2. In a union shop, an employer may hire nonunion workers, but they must join in a
specified period of time.

3. An agency shop requires nonunion workers to pay dues or donate a similar amount to
charity.

4. In an open shop, the employer may hire union or nonunion workers. Workers are not
required to join the union or contribute; but the work agreement applies to all workers union
and nonunion.

5. Most work agreements contain clauses outlining the decisions reserved solely for
management; these are called managerial prerogatives.

C. The focal point of any bargaining agreement is wages and hours.

1. The arguments most frequently used include for wage increases are:

a. What others are getting;

b. Employers ability to pay based on profitability;

c. Increases in the cost of living; and

d. Increases in labor productivity.

2. In some cases, unions win automatic cost-of-living adjustments (COLAs).

3. Hours of work, voluntary and mandatory overtime, holiday and vacation


provisions, profit sharing, health plans, and pension benefits are other contract issues.
D. Unions stress seniority as the basis for worker promotion and for layoff and recall and
sometimes seek means to limit a firms ability to subcontract work or to relocate production
facilities overseas.

E. Union contracts contain grievance procedures to resolve disputes.

F. The bargaining process.

1. Collective bargaining on a new contract usually begins about 60 days before the existing
contract expires.

2. Hanging over negotiations is the deadline which occurs at the expiration of the old
contract, at which time a strike (union work stoppage) or a lockout (management forbids workers
to return) can occur.

3. Bargaining, strikes and lockouts occur within a framework of Federal labor law,
specifically the National Labor Relations Act (NLRA).

III. Economic Effects of Unions

A. The union wage advantage is verified by studies that suggest that unions do raise the
wages of their members relative to comparable nonunion workers; on average, this pay
differential over the years is estimated to have been about 15 percent.

1. The overall average level of wages of all workers has probably not been affected by
unions (Figure 2).

2. Union workers seem to gain at the expense of nonunion workers.

3. Real wages overall still depend on productivity.

B. Efficiency and productivity are affected both positively and negatively by unions.

1. The negative view has three major points.

a. Featherbedding and work rules make it difficult for management to be flexible and to use
their workers in the most efficient ways.
b. Strikes, while rare, do constitute a loss of production time and affect certain industries
more than others.

c. Labor misallocation might occur as a result of the union wage advantage, but studies
suggest that the efficiency loss is minimalperhaps only a fraction of one percent of U.S. GDP.

2. The positive view has three major points as well.

a. Managerial performance may be improved when wages are high because managers are
forced to use their workers in more efficient ways. This is called the shock effect.

b. Worker turnover may be reduced where workers feel they can voice dissatisfaction and
have some bargaining power. (Using the voice mechanism rather than the exit mechanism)

c. Seniority promotes productivity because workers do not fear loss of jobs, and informal
training may occur on the job because workers do not compete with one another in a seniority
based system.

3. Research findings have been mixed. Some have found a positive effect of unions on
productivity, while an almost equal number have found a negative effect of unions on
productivity.
The lesson content has been compiled from various sources in public domain including but not limited to the
internet for the convenience of the users. The university has no proprietary right on the same.

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