Compensation and Reward

Management
Chapter 8
Tanuja Agarwala
 Compensation and Rewards
 Compensation is the sum total of all forms of payments and rewards
provided to employees for performing task to achieve organizational
objectives.
 Compensation and rewards management is a complex process that includes
decision regarding benefits and variable pay and is one of the most
significant and dynamic of HR practices.

 According to, Benham: Compensation is the value of work of the

employees according to the agreement between employer and employee.
 Types of Benefits
 Benefits are of two types:
1. Mandatory benefit
2. Voluntary benefit
 There are other types of benefits
• Structuring benefits
• Segmentation
 Types of Benefits
1. Mandatory Benefit: These benefits are legally binding on the employer.
Provident funds, gratuity schemes, health plans, maternity leave, medical
leave, etc. are examples of mandatory benefits.
2. Voluntary Benefit: These are discretionary and are provided by the
employer voluntarily. These include compensation for time not worked,
for example paid holidays, Family-friendly benefits, retirement
benefits, etc.
 The Non-financial Components
 The non-financial components of the compensation package is an important
aspects because financial compensation is no longer the only
differentiator.
 Intrinsic motivators, such as getting a challenging assignment, chance to
do something worthwhile, etc. are as important as the financial package.
 Job Evaluation
Job evaluation the process of determining the relative value of the job to assign
a wage rate to the job, is used to determine the base salary.
The purpose of job evaluation is to ensure that there is pay equity within the
organization, that is pay levels of jobs reflect their relative worth.

There are four methods of job evaluation:

1. Ranking
2. Classification
3. Point
4. Factor comparison.
Ranking Management representatives and employees examine each job description and arrange
the jobs in order of importance.
Simplest and oldest method.

Classification Jobs are classified and grouped into number of grades classes. Each successive grade or
class requires increasing amounts of job responsibility, skill, ability etc.
Also a simple method.

Point The job is broken down into specific components such as skill, effort responsibility etc. and
numerical values are assigned to each of these components.
Expensive and time consuming but widely used.

Factor Evaluators do not evaluate the complete job, but separate factors of the job. These factors
Comparison are called compensable factors. It is assumed that there are five universal job factors
mental effort, skill, physical effort, and responsibility and working conditions.
A factor comparison scale reflecting ranking and money allocation is developed.
 Types of Incentives
Individual Incentives
1. Piecework Plans
2. Merit Pay
3. Bonus
Individual Incentives for Sales Personnel
1. Salary Plan
2. Commission
3. Combination Plan
 Types of Incentives
Group / Team-based Incentives
1. Work-team Plan
2. Gain-sharing
Organizational Incentives
1. Profit-sharing Plans
2. Employee Stock Option Plans (ESOP)
 Reward Preferences and Characteristics
Category of the Employee Characteristics and Reward Preference
Self Powered Innovators  Impassioned and energized by their work;
 Prefer to be given work that empowers them and enables them to learn and grow
 Less motivated by traditional rewards like additional compensation and vacation
time.
Fair and Square  Reliable and loyal family people who desire traditional rewards;
Traditionalists  Least interested in risky compensation packages containing bonuses and stock
options;
 Less interested in soft benefits like stimulating work, enjoyable workplaces, or
flexible work arrangement.

Accomplished Contributors  Take pride in what they do, are team players;
 Value comfort and security and prefer an environment that is co-operative,
congenial, and fun.
 Reward Preferences and Characteristics
Category of Employee Characteristics and Reward Preference
Maverick Morphers  Young and restless, want flexible work schedules that allow them to pursue
their own interests;
 Prefer bonuses and stock options.

Stalled Survivors  Work is not the most important or satisfying part of their lives;
 Younger employees who are getting married, having children, exploring
alternative career avenues and viewing their current job as a temporary
phase;
 Prefer flexible work arrangement, added pay, and vacation time.

Demanding Disconnects  Feel disgruntled and dead-ended by lack of opportunity;

 Struggle to make ends meet, hence place high value on traditional
compensation and benefits.
 Compensation and Rewards - Determinants
External And Internal Determinants Of Individuals Financial Compensation
 Internal Determinants of Pay Levels
 Compensation Policy of the Organization: It determines the organization's ability to attract and
retain employees. Organization adopt different policies for different compensating employees. An
organization that pay higher wages and salaries than competing firms is the pay leader and attracts
better workers and so achieve lower cost per unit of labor.
 Employer's Ability to Pay: An employer's ability to pay employees and provide them benefits is an
important determinants of pay levels. It is influenced by factors such as budget available, profit of
the organization, economic conditions, competition faced by employers etc.
 Worth of the Job: Organization pay for the duties, responsibilities, working conditions and effort
required on the part of employees. The relative worth of jobs is determined and jobs with higher
worth are paid more. Organization that base their pay levels on the worth of the job rely on job
evaluation.
 Employee's Relative Worth: It determines pay levels and influences the notion of quality. When
individual compensation and reward is linked to employee performance, performance appraisal data,
provide the input of determining employee pay levels.
 External Determinants of Pay Levels
Labor Market Conditions: The forces of demand and supply for qualified people within an
area influence wage and salary rates. When demand for human resources is high and supply is
limited, wages and salaries are higher in order to attract and retain the qualified employees.
Economic Conditions: The degree of competitiveness of the industry affects an organization's
ability to pay. An organization that has high productivity will be able to pay more. Advanced
technology, higher operational efficiency, a skilled workforce or all of these can increase
productivity.
Area Wage Rates: The rates being offered by other organizations for similar jobs in the same
geographical area influence an organization's wage rates, and therefore its ability attract,
recruit, and retain competent employees. IBM is a firm that offers competitive salaries.
 External Determinants of Pay Levels
Government Controls: These influence the rate of pay through legislation such as the
minimum Wages Act 1984 and the Payment of Wages Act 1936 that establish minimum wages
rates for certain categories of employees and also prevent discrimination. For example,
organizations are offered allowances under different sub-heads to minimize their tax liability.
Cost of Living: Increased in the cost of living raise the cost of goods and services.
Compensation rates are revised upward periodically to help employees maintain their
purchasing power. These changes in compensation rates are made on the basis of consumer
price index ( CPI).
Union Influences: Union negotiations tend to establish the wage patterns for the region. Union
bargain collectively over working conditions and wages rates to obtain increase that are larger
and more favorable than the established pattern in a Geographic region. Wages are generally
higher in those areas where organized labor is strong.
 Pros and Cons of Performance - Reward Linkage
Performance Reward Linkage
Pros Cons
* Each employee is rewarded on the basis of * May be counterproductive if appraisals are seen as
individual output; unfair;
* Individual performance - reward linkage is * Increase in pay is not meaningful after pat for non-
motivational; performance factors such as seniority and cost of
* Employee has some control over total living is subtracted from the increase;
compensation. * Timing of rewards is tied to budget rather than to
task accomplishment, reducing the motivational value
of the rewards.
Compensation and Rewards - Approaches

Approaches to
compensation

Traditional Contemporary
compensation compensation
approach approach

Skilled based or
Based on job Rewards linked
Job-based pay competency
evaluation to performance
based pay
Types of Pay-for-Performance Approaches
 Types of Pay-for-Performance Approaches
Merit pay: Merit pay is the pay increase given to employees based on their performance as
indicated in the appraisal, and is the most widely used approaches to reward individual
performance. It is usually extended to reward an employee's performance over a period. The
best performing employee gets the highest merit pay.
Variable pay: With high levels of competition confronted by organizations, it has become
important that organizations control labor costs also maintain high levels of employee
performance. Variable pay meets these objectives by rewarding high performance.
Rewards provided for good performance during previous employment period are not added to
the base pay ; instead, a lump sump amount is given such as bonuses and incentives etc.
Skill-based pay: Skill-based pay is premised on the belief that employees who possess
more knowledge and skills are more valuable to the organization and therefore should be
rewarded accordingly : it compensates employees for job skills and knowledge and not for
job titles.
Competency-based pay: Competencies include not only skills and knowledge, but also
factors such as motives, traits, attitudes etc. Competency-based pay rewards employees
for the expertise they bring to the organization.
 Types of Equity

Types of Equity

Internal Equity External Equity Individual Equity

 Types of Equity
Internal Equity: it ‘exists when are paid according to the relative value of their jobs
within the same organization’. Employees should feel that differences in compensation
levels between jobs are fair given the differences in job responsibilities. Job evaluation
forms the basis for determining internal equity. If the sales manager feels that his pay is
fair when compared with that of the production manager, there exists internal equity.
External Equity: it exists when the employees of one organization feel that they are
paid comparably to employees who perform similar jobs in another organization.
When a sales manager in a firm feels that his salary compares well that of a sales manager in
another organization, there exists external equity in another firm rates.
Individual Equity: it exists when an employee perceives that his or her pay is fair when
compared with what co-workers are earning for similar jobs within the company,
based on each individual’s performance.
 Compensation and Rewards Development
Competency-based pay and reward programs: A competency-based pay system is
one in which employees are paid for the range of skills, knowledge, motives,
attitudes etc. that they bring to the job rather than for the job title they hold. Employees
are paid what they can do even if they do not have to do it now. It is people-based
not job-based. Competency-based system allows the top performer of an organization to be
distinguished from other employees.
Team-based pay and rewards: Team-based pay is a system of compensation in which
managers at a company reward members of a project or a department team with
bonus compensation or pay increases based on their performance or the
successful completion of goals. The rewards may be in forms of cash, such as bonuses, or
in the form of indirect compensation such as vacation, time off from work, stock ownership,
etc.
Steps in Setting up a Competency-based Pay System

Step 1: Identify competencies and distinguish between

proficiency level

Step 2: Assess the competency level of job-holders

Step 3: Create pay bands

Step 4: Develop a pay delivery system

Advantages and Disadvantages of Team-based Pay and Rewards
Advantages
 Overcomes the difficulty inherent in
measuring individual contributions
 Facilitates co-operation’
 Establishes a string link between desired
behavior and rewards by awarding team
bonuses shortly after a project is completed
 Motivates high-performing members to
train other members when team rewards
are withheld until all members are cross-
trained. Team rewards get tied to skill
development.
Disadvantages
 May foster unhealthy inter-team
competition and conflict
 May de-motivate hard workers if individual
pay is perceived to be lower than
proportionate to effort
 Team members who do not put in much
effort may get rewards equivalent to high-
performing team members
 May be successful only when organizational
culture supports the team-based pay
concept
 Trend in Top-level Executive Compensation

A CEO’s compensation includes:

• An employee stock option plan (ESOP);
• Underwritten stock options;
• A retention bonus;
• A free residence (if the employee stays on, the organization gifts to the employee the
house that he/she is living on);
• A sign-on bonus, to ensure commitment;
• A joining bonus or a ‘golden hello’ (to compensate the loss of the existing job);
• Severance pay (if one party decided to rescind the contract, it will pay a certain
amount to the other); and
• A pre-joining holidays.
 Dimensions of Compensation
Compensation Dimensions Description

1. Bases for Determining

Pay levels
Job or Skill The traditional job-based system is based on job evaluation.
Skill-based pay focuses on individual skills rather than on the job.
Performance or Seniority Rewards may be based on performance or seniority
Individual Performance or Rewards and pay may be based on individual performance or on group
Group Performance performance. Organization prefer to use a combination of both.
Short time orientation or Rewards may be based on the short term objective and performance of the
Long time Orientation organization or its long term objectives and performance.
Risk Aversion or High growth firms may use rewards to encourage individual risk-taking, while
Risk Taking mature firms may align rewards with risk aversion.
Compensation Level or Comparison of the total compensation package with the competition through
Market wage surveys, benchmarking etc.
Internal Equity or Rewards may be designed to ensure internal equity or to ensure external equity.
External Equity
 Dimensions of Compensation
Compensation Description
Dimensions
Hierarchy or An organization may link money and perquisites with the movement up the
Egalitarianism corporate hierarchy or de-link two and pay for performance and capabilities,
allowing individuals to earn more without upward movement.
Fixed pay or Incentive Mature firms may emphasize higher fixed pay and offer more security. High-growth
firms may encourage more risk by offering higher incentives and low base pay.
Quantitative or Firms may use quantitative or qualitative measures to measure organizational
Qualitative performance. Firms growing through mergers and acquisitions should use
Measures of quantitative performance measures,while firms trying to be first movers in new
Performance product and market areas should utilize qualitative measure of performance.
2. Design of
Compensation System
Bonuses or Deferred Firms that focus on short term performance may pay frequent bonuses. Firm that
Compensation focuses on long term performance may defer compensation.
Intrinsic Rewards or Firms may focus on intrinsic rewards(achievement, recognition and job satisfaction)
Extrinsic Rewards or on extrinsic rewards(incentives).
 Dimensions of Compensation
Compensation Dimensions Description
3. Administrative
Framework
Centralized Pay Administration Pay decision may be controlled by corporate headquarters (centralized
or Decentralized pay pay administration) or by plants, divisions etc.(decentralized pay
Administration administration).
Open Pay or Secret Pay Firms may keep issues open (thereby encouraging communication and
involvement) or secret (thereby diminishing trust)
Participation or Firms may or may not encourage employees to participate in pay
Nonparticipation of Employee decisions. Firms that employ non traditional compensation system and
in Pay Decisions highly knowledgeable workers include employees in the process to
decide pay, firm that are bureaucratic do not.
Bureaucratic Pay Polices or Compensation system may be highly formalized and inflexible or it may
Flexible Pay Policies be flexible. Compensation system should be formalized, but flexible
enough to allow for changes. However too frequent a change in pay
system can lead to lack of alignment with organizational strategy.
 Strategic Compensation Strategies
Mechanistic Compensation Strategies Organic Compensation Strategies
 Make pay decision routine  More responsive to changing conditions,
 Applied uniformly across the entire organization contingencies, and individual situations

Basics for Pay Basics for Pay

 Pay for performed, not employee skills  Pay for skills
 Emphasis on seniority-based pay  Pay for performance
 Base salary related to individual performance  Both group and individual appraisals
appraisals  External equity
 Internal equity  Egalitarian
 Foster hierarchical emphasis  High risk-taking
 Minimum risk-taking  Long-term focus
 Quantitative performance measures
 Short-term focus
 Strategic Compensation Strategies
Mechanistic Compensation Strategies Organic Compensation Strategies
Design to Pay Design of Pay
 Pay higher than the market rate  Pay less than the market rate
 Fixed pay more than incentives  High incentives in pay mix
 Frequent bonuses  Use of bonuses and deferred income
 Intrinsic rewards  Extrinsic rewards

Administrative Framework Administrative Framework

 Centralization  Decentralization
 Secrecy of pay  Open pay policies
 Lack of employee participation  High employee participation
 Bureaucratic policies  Flexible compensation programmes
Business Strategy and Compensation Strategy Linkage
Business Strategy
(Miles and snow Typology)
Defender Strategy (maintain current market
share)
Characteristics
 Maintenance strategy
 High commitment to existing product
 Expand in correct product areas and in
related areas of expertise
 Obtain high percentage of revenue from a
single business or product
 Mature companies
Compensation Strategy
Mechanistic Strategy
 Provide pay package and policies to
maintain in-grown talent needed to
enhance the existing business
 Reward work experience with the firm or
seniority because long tenure with the
organization provides expertise to preserve
the current business strategy
 Business Strategy and Compensation Strategy Linkage
Business Strategy
(Miles and snow Typology)
Prospector Strategy (actively search for new
products and markets and purchase
opportunities both within and outside current
area of expertise) Characteristics
 Dynamic growth strategy
 Take financial risk
 Use unrepeated business strategy to grow
 Diversify by entering new markets
Analyzer Strategy (limited diversification and
dependence on a single product)
 Dominant product strategy
Compensation Strategy
Organic Strategy
 Seek external equity in compensation
strategies
 Reward patterns control outcomes
(achievement of goals) rather than evaluate
behavior used to attain goals.
 Seek to minimize fixed cost due to fast
growth and risk associated with business.
 Higher level of incentive pay
Mixed compensation strategy
 Provide both control and autonomy
 Types of Industry
Technology -intensive Industry:
High -technology firms develop compensation strategies that are congruent with the
culture of innovation. Some attributes and characteristics of high technology firms are:
1. Individual -based compensation strategy
2. Risk- sharing compensation strategy
3. Market driven pay
4. Higher discretion
5. Aggregate incentives
Emerging and Rapidly- growing Industries
Emerging and rapidly -growing industries are defined as those industries that are newly
formed or revitalized industries that have been created by technological Innovations,
changing cost factors, or new customer demands that elevate a new product or service
into a potentially attractive business opportunity
 Total compensation and Reward Strategy
• A total compensation and reward strategy defines the compensation and reward programs, the
individual elements of this programmed, and the ways in which the elements relate to each other to
fulfill compensation and reward objectives. .
• A total compensation and reward strategy is a statement of an organization’s HR philosophy related to
rewards, or the organization’s compensation and reward philosophy. It is important that organization
have a well-conceived total compensation and reward philosophy that embodies the values and benefit
of the organization.
• This philosophy should serve to guide the design of reward program as well as to measure their
effectiveness.
 Components of Total Compensation and Rewards Strategy
The design of total compensation and reward strategy require that decision must be made regarding the
overall objectives of the reward program; the competitiveness of reward program; and the type and the
mix of reward. Therefore, the formulation of the total compensation and rewards strategy should
incorporate
1. A comprehensive audit or assessment of current programmes;
2. Internal business factors; and
3. External environmental and market factors.
Organizational life Cycles and Compensation Strategy

Organizational Life- Cycle Compensation Strategy

Start-up stage  low base pay (to conserve cash)
 high emphasize on incentive pay
low benefits
Growth stage High dependence on incentive pay to attract and retain
R&D scientists and engineers
stock options, profit sharing , bonus
Mature stage less likely to use incentives pay strategy
Decline stage high base salary and benefits
less flexibility to offer pay incentives
Reward System Components of Rapidly-Growing Firms
Reward system components Characteristics

Base Pay/Salary  Pay level at market rates to successfully recruit new employees and to
attract experienced employees from mature firm
 External pay equity, that is, competitive pay
 Job evaluation used only to rank jobs based on internal worth
Benefits  Competitive with other benefits program available in the market
 Profit sharing plan to fund retirement benefits
 ESOPs
Short-Term Pay Incentives  Place a significant portion of the employees’ total compensation at risk
 Individual pay incentives such as merit pay
 Aggregate or group- level incentives such as cash- bonus
 Profit sharing to reward organizational performance

Long term Pay Incentives  Recognition and reward of key employees who make major contributions to
the success of the firm
 ESOPs
Thank you.