COMPENSATION

MANAGEMENT
THEORIES OF COMPENSATION 1

Course Code: HRM101

L: 23-25
 LEARNING OBJECTIVES

• Identify the different components of

remuneration
• Describe the theories of wage and salary
payments
• Identify the variables that influence
employee remuneration
• Point out the wage policy of Government
• Explain the wage concepts
• Explain how special groups can be
compensated
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 DEFINITION

Compensation is defined as the total amount of the

monetary and non-monetary pay provided to an
employee by an employer in return for work
performed as required.
So compensation/remuneration contains 2
aspects:
Financial
Non-financial

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 COMPONENTS OF EMPLOYEE
REMUNERATION
Environment

Remuneration

Financial Non-financial

Job Context
Fringe Benefits Perquisites Challenging job
PF Company car Responsibilities
Hourly and
Incentives Gratuity Club membership Recognition
Monthly rated
Individual plans Medical Care Paid holidays Growth prospects
Wages
Group plans Accident Relief Furnished house Supervision
Salaries
Health and Group Stock option Working
Insurance, etc. Schemes, etc. conditions
Job sharing, etc.

Direct Indirect

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 COMPONENTS OF EMPLOYEE
REMUNERATION
• Wages and Salary: wages are hourly rates of pay
whereas salary is monthly rate of pay.

• Incentives: are paid on and above salary/wages;

depends on productivity, sales, profit or cost
reduction efforts. 2 types:
Individual
Group
• Both together comprises “direct compensation”.

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 DIFFERENCE BETWEEN WAGES &
SALARY
Wages Salary

Paid to semi-skilled or unskilled Paid to skilled personnel

personnel
Rates are flexible Rates are fixed

Payments are made daily/weekly Payments are made monthly

Paid on the basis of hrs worked Paid on the basis of performance

Amount paid is variable Amount paid is fixed

No KRA’s are fixed KRA’s are fixed

Additional money aid for extra hrs No additional money is paid for
worked extra hrs
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 COMPONENTS OF EMPLOYEE
REMUNERATION
• Fringe Benefits: provided to an employee outside
of his normal wage or salary. 2 types:

Taxable
Non-taxable

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 COMPONENTS OF EMPLOYEE
REMUNERATION
• Perquisites: any casual emolument or benefit
attached to an office or position in addition to
salary or wages. Usually it is non-monetary in
nature.
Value of perquisites is chargeable to tax under
the head salary only if these perks are received
by an employee from his or her employer and
employer.
In case any perk has been received from a person
other than employer, then also the value of perk
is taxable but either under the head ‘Business or
Profession’ or ‘Income from other Sources’.

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 THEORIES OF REMUNERATION

• Reinforcement theory
• Expectancy theory
• Equity theory
• Agency theory

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 REINFORCEMENT THEORY

• A behavior which has a rewarding experience is

likely to be repeated.

• So a high employee performance followed by

monetary reward will make future employee
performance likely and vice versa.

• Emphasizes the importance of a person actually

experiencing the reward.

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 EXPECTANCY THEORY

• Taken from Vroom’s Expectancy Theory.

• Motivation is the product of valence, instrumentality and

expectancy.

• Pay systems differ most in their impact on

instrumentality.
• Valence of pay outcomes remain the same under
different pay systems
• Expectancy perceptions often have more to do with job
design and training than pay systems.

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 EXPECTANCY THEORY

• Valence is the significance associated by an

individual about the expected outcome.
• Expectancy is the faith that better efforts will
result in better performance.
• Instrumentality is the faith that if you perform
well, then a valid outcome will be there.

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 EXPECTANCY THEORY

Expectancy theory predicts that employees in an

organization will be motivated when they believe that:

• Putting in more effort will yield better job

performance (expectancy)
• Better job performance will lead to organizational
rewards, such as an increase in salary or benefits
(Instrumentality)
• These predicted organizational rewards are valued
by the employee in question (Valence)
https://www.yourcoach.be/en/employee-motivation-theories/vroom
-expectancy-motivation-theory.php

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 EQUITY THEORY

• An employee who perceives inequity in his or her

rewards seeks to restore equity.
• Remuneration system needs to meet three types
of equity which directly impact motivation,
commitment and performance-
Internal Equity
External Equity
Individual Equity
• When employee perceives inequity it can result in
lower productivity, higher absenteeism or
increase in turnover.
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 AGENCY THEORY

• Focuses on the divergent interests and goals of

the organization’s stakeholders and the way that
employee remuneration can be used to align
these interests and goals.

• 2 main stake holders: employers and employees

• Employers are principals; while employees are
agents
• Wages paid to the employees are considered as
agency cost.

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 AGENCY THEORY

• Employees expect high agency cost, while

employers seeks to minimize it.

• Agency theory says that principal must choose a

contracting scheme that helps align the interest
of agent with the principal’s own interest.

• 2 types of contracts: behavior oriented, outcome

oriented

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CONSEQUENCES OF PAY DISSATISFACTION

Performance

Strikes
Desire for More
Pay
Grievances

Absenteeism
Search for Higher
Paying Jobs
Turnover

Pay Lower Attractiveness

Dissatisfaction of Job Job Psychological
Dissatisfaction Withdrawal

Absenteeism Visits to the

Doctor

Poor Mental
Health
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 MCQ’S

1. Providing equal pay for jobs of equal

nature based on job evaluation ensures
_______ in compensation administration.

a. external equity
b. internal equity
c. neutrality
d. None of the above
Ans A
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 MCQ’S

2. Payment of cash rewards for the work

extracted from the employee is normally
called

a. indirect compensation
b. direct compensation
c. non-monetary compensation
d. None of the above
Ans B
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 MCQ’S

3. Which of the following is the fixed

component in compensation packages?

a. Profit-sharing
b. Base salary
c. Gain-sharing
d. Equity stock options

Ans B
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 MCQ’S

4. Insurance schemes, retirement benefits

and leave travel concession are examples
of

a. indirect monetary compensation

b. direct monetary compensation
c. non-monetary compensation
d. None of the above
Ans A
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 MCQ’S

5. Managers never own complete

responsibility for the all the decisions made
by them since they are not the owners of
the business is the assumption of

a. equity theory
b. expectancy theory
c. agency theory
d. contingency theory
Ans C
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 NEXT CLASS

Factors Influencing Employee

Compensation

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INFLUENCING FACTORS OF
REMUNERATION

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 EXTERNAL FACTORS

Labor market
•Demand and supply of labor influences the
wage/salary fixation.
•When supply exceeds demand, a lower wage may
be fixed and vice versa.
•Going rate of pay & productivity also has an effect
on wage fixation.

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 EXTERNAL FACTORS

Cost of Living
•During rising prices cost of living increases , and
is forgotten when prices are stable or falling.
•A rise in the cost of living is sought to be
compensated by payment of dearness allowance,
basic pay to remain undisturbed.
•Many companies include an escalatory clause in
their wage agreements in terms of which dearness
allowance increases or decreases depending upon
the movement of consumer price index (CPI).

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 EXTERNAL FACTORS

Labor Unions
•Presence or absence of labor organizations often
determine the wages paid to employees.
•The employees of strongly unionized companies
too, have no freedom in wage and, salary fixation.
•Non unionized companies can fix wages as they
please.

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 EXTERNAL FACTORS

Labor Laws
• Payment of Wages Act, 1936 was passed to
regulate payment of wages to certain classes of
persons employed in the industry.
• The Minimum Wages Act, 1948 enables the
central and the state governments to fix minimum
rates of wages payable to employees in sweated
industries.
•The Payment of Bonus Act, 1965 provides for
payment of a specified rate of bonus to employees
in certain establishments.

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 EXTERNAL FACTORS

Labor Laws
•The Payment of Bonus Act, 1965 provides for
payment of a specified rate of bonus to employees
in certain establishments.
•The Gratuity Act, 1972 provides for payment of
gratuity to employees after they attain
superannuation.
•The Equal Remuneration Act, 1976 provides for
payment of equal remuneration to men and women
workers for same or similar work.

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 EXTERNAL FACTORS

Labor Laws
•In addition to legal enactments, there are wage
boards, tribunals and fair wages committees which
aim at providing a decent standard of living to
workers.

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 EXTERNAL FACTORS

Society
•Remuneration paid to employees is reflected in
the prices fixed by an organization for its goods
and services. For this reason, the consuming public
is interested in remuneration decisions.

•The financial position of the employer and the

state of the national economy have their say in the
matter of wage fixation.

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 EXTERNAL FACTORS

Economy
•A depressed economy will probably increase the
labor supply. This, in turn, should serve to lower
the going wage rate.
•Since the cost of living is commonly used as a pay
standard, the economy’s health exerts a major
impact upon pay decisions.

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 INTERNAL FACTORS

Job Evaluation and Performance Appraisal

•Job evaluation helps establish satisfactory wage

differentials among jobs.
•Performance appraisal helps award pay increases
to employees who show improved performance.

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 INTERNAL FACTORS

Business Strategy
•Where the strategy of the enterprise is to achieve
rapid growth, remuneration should be higher than
what competitors pay.

•Where the strategy is to maintain and protect

current earnings, because of the declining fortunes
of the company, remuneration level needs to be
average or even below average.

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 LINKAGE OF REMUNERATION STRATEGY
TO BUSINESS STRATEGY

Market Position and

Business Strategy Remuneration Strategy Blend of Remuneration
Maturity

High cash with above

Stimulate average incentive for
Invest to grow Merging or growth rapidity
entrepreneurialism individual performance.
Modest benefits,

Average cash with

moderate incentives on
Manage earnings-protect
Normal growth to maturity Reward management skills individual, unit, or corporate
markets
performance. Standard
benefits.

Below-average cash with

Harvest earnings-reinvest
No real growth or decline Stress small incentive tied to cost
elsewhere
control. Standard benefits.

Source: Wayne F. Cascio, Managing Human Resources, McGraw-Hill, 1995, p.352.

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 INTERNAL FACTORS

The Employee
•Several factors like performance, seniority,
experience, potential, and even sheer luck
influence remuneration.

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DEVISING A REMUNERATION PLAN

• Any remuneration plan has to workable,

understandable and acceptable.

• These 2 components are a must- a base rate and

a scope for increasing the base rate.

• A remuneration plan has certain sequential steps:

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REMUNERATION MODEL

Job Description

Job Evaluation

Job Hierarchy

Pay Survey

Pricing Jobs
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 NEXT CLASS

Challenges in Compensation
&
Job Evaluation

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 RAISING SALARIES

• http://money.cnn.com/2017/12/12/pf/pay-salary-
work-inflation/index.html

• https://timesofindia.indiatimes.com/business/india
-business/india-to-see-10-salary-increase-in-2018-
report/articleshow/61583079.cms

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41
CHALLENGES OF REMUNERATION

Skill-based
Pay
Monetary
vs. Non- Salary
Monetary Reviews
Rewards

Employee Pay
Participation
Remuneration Secrecy

Below Market
Eliticism or
or Above
Egalitarianism
Market Rates
Comparable
Worth
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 SKILL-BASED VS. JOB BASED PAY

• Is when an employee is given remuneration based

on the number of skills he possess or on the depth
of knowledge.

• The purpose is that it motivates employees to

acquire additional skills.

• Works when there is supportive HRM

philosophies, frequent technological changes,
employee turnover is high, workers value
teamwork
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 SKILL-BASED PAY AND JOB-BASED PAY
COMPARED

Factors Job-based Skill-based

Pay structure Based on job performance Based on ability to perform

Job carries wage; Employee linked to Employee carries wage; Employee

Employer’s focus
job linked to skills.

Employee focus Job promotion to earn greater pay Skill acquisition to earn greater pay.

Advantages Pay based on value of work performed Flexibility; Reduced workforce.

Potential personnel bureaucracy; Potential personnel bureaucracies; Cost

Disadvantages
Inflexibility controls.

Source: Raymond A. Stone, Human Resource Management, John Wiley & Sons, 1995, p.324.
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 PAY REVIEWS

• Once fixed it should not remain constant. The

question is how often.

• Many private firms use a 12 month period for pay

revisions

• Organised sector sees a wage revision in 3 years

• Government departments revise their payments

once in 10-15 years. Or based on the
recommendations of the Pay Commission.
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 PAY SECRECY

• How and what kind of information regarding the

pay structure should be given to the employees is
a question that troubles HR managers.

• Organised and public sector enterprises usually

disclose full information regarding wages and
salaries.

• Pay secrecy can affect the motivation of

employees.

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 COMPARABLE WORTH

• Inspired by the Equal Remuneration Act.

• This principle says that if 2 jobs receive the same

points in job evaluation, the same wage/salary
should be paid.

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 EMPLOYEE PARTICIPATION

• Employee participation is to be ensured in devising a

remuneration plan.

• Participative management as well as a reasonable

organizational trust should be developed before this can be
implemented.

• Methods by which the employees can be involved is – job

evaluation committees, wage survey, employee task forces
•

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 ELITICISM VS. EGALITARIANISM
• Egalitarianism offers more flexibility to deploy employees in
different areas without any change in pay levels.

• Egalitarianism work for companies who are operating in highly

competitive environments.

• Elitist pay structure tends to result in more stable work-force

because employee makes more money only by moving through
the company.

• Elitist remuneration system are prevalent in older, well-

established firms.

•
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 BELOW MARKET VS ABOVE MARKET
REMUNERATION
• Depends on the strategy of the organization.

• Depends on the organization’s ability to pay.

• Depends on the organization’s image and ability to

retain employees.

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ANALYZE WHO WILL PAY AN ABOVE
AVERAGE REMUNERATION

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 MONETARY VS NON-MONETARY
REWARD.
• Decisions regarding this has tax implications.

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 WAGE CONCEPTS

• Are broadly based on the needs of the workers,

capacity of the employee to pay and economic
conditions of the country.
• Minimum wage
• Provides for sustenance of life but also for preserving
efficiency of the worker.
• A minimum wage is a compensation to be paid by an
employer to his workers irrespective of his ability to pay.
• minimum wage must provide some measures of education,
medical requirements and amenities.

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 WAGE CONCEPTS

• Fair wage
• Comparable with standard wages elsewhere
• A living wage is fixed considering the general economic
conditions of the country.
• Includes not only the bare essentials of food, clothing and
shelter but a measure of frugal comfort including
education for his children, protection against ill-health,
requirement of essential social’ needs and a measure of
insurance against the more important misfortunes,
including old-age.
• Living wage
• providing essentials plus certain comforts

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 WAGE CONCEPTS

• Living wage
• the wage which is above the minimum wage but below the
living wage
• providing essentials plus certain comforts
• Depends on productivity, prevailing rates, and level of
national income

http://www.yourarticlelibrary.com/employee-
management/wages/wage-payment-methods-4-top-methods-
of-wage-payment-explained/35345

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 REALITY CHECK

• How far luck does influence pay? Have you come

across any individual who has been lucky enough
to be more than he or she deserves?

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