CHAPTER 5

COMPENSATION SYSTEM
 Content

5.1 Definintion and role of compensation

5.2 Method of compensation

5.3 Organizing the compensation system

• About 80% of employees would rather have new
benefits than a pay rise;
• 72% of employees admit that an increase in non-
monetary benefits would increase their job
satisfaction;
• Companies with more attractive benefits and
compensation packages had a 53% decrease in
their turnover rate;
• 79% of employees from Generation Z and
Millennials recognise that an increase in their
rewards for recognition would increase their
connection with the company.
 Yes/No
A percentage salary increase is more equitable than
an equal salary increase for everyone

It is only fair that senior managers are paid more

than lower-level employees

Pay based on performance causes division among

employees

Every employee has the right to receive an annual

salary increase
COMPENSATION???
The term compensation represents the exchange between
employees and organization, both gives something in return
for something else. In the past, the compensation issues were
often confidential and govern by individual employer’s
preferences and choices. However in today’s competitive
world the compensation policies are more transparent and the
employees take their own choices based on the compensation
package. Thus, balancing the cost of compensation and
retaining the employees have become the most important
priority for the organization
(Bhattacharyya 2009).
According to Cascio (1995) the “Compensation includes direct
cash payments and indirect payments in form of employees
benefits and incentives to motivate employees to strive for
higher levels of productivity”.

According to Milkovitch and Newman (2005) the

“Compensation is all forms of financial returns, tangible
services and benefits employees receive as part of an
employment relationship.” The phrase “financial returns”
refers to an individual's base salary, as well as short- and long-
term incentives. “Tangible services and benefits” are such
things as insurance, paid vacation and sick days, pension
plans, and employee discounts.
5.1. Definition and role of compensation

• Compensation system is a powerful tool for meeting

the organization’s goals.
• Compensation system has a large impact on employee
attitudes and behaviors.
• It influences the kinds of people who are attracted to
(or remain with) the organization.
• Compensation refers to any payment given by an employer
to an employee during their period of employment. In return,
the employee will provide their time, labor, and skills.
• This compensation can be in the form of a salary, wage,
benefits, bonuses, paid leave, pension funds, and stock
options, and more.
 Objectives of
Compensation
Establish Equity

Increase Worker's Efficiency

Macroeconomic Stabilization

Effective Distribution of Labour

Maintain Income-Expenditure Ratio

Avoid Conflicts

Legal Compliance
 Role of Compensation

Organization Employee Society

• Attract and Retain • Maintain high • Increasing
quality employees productivity economic benefit
• Build productivity • Encourage • Improve citizen’s
labor force employee benefit
• Improve the motivation
organizational • Encourage
brand employee’s
• Improve the innovation
relationship • Employee’s
employees and loyalty
employers
 For business activities of the enterprise
• Compensation is a sufficient condition to improve the
quality and efficiency of an enterprise's business
operations.
• Workers' compensation contributes to maintaining a
stable human resource of the enterprise because it
provides material conditions and a simple reproduction
process and expands "labour power".
• Compensation contributes to positive effects on other
human resource management activities in the
enterprise.
• Reasonable compensation of workers contributes to
saving costs for businesses.
 For satisfying the needs of employee
• Compensation creates motivation and stimulates workers
to work.
• Compensation for workers creates conditions for workers
to constantly improve their material lives, helping them to
get along with increasingly modern and civilized social life.
• Compensation gives employees confidence in the
business, their work and the people around them, which is
the "spiritual strength" for them to work better, contribute
more and be loyal to the business. more professional.
5.2. Method of compensation

Financial Non-financial
compensation compensation

• Direct monetary for • In-direct monetary for

employees employees
 Financial compensation in businesses is
remuneration provided by financial instruments
including many different types: salaries, bonuses,
allowances, benefits, shares...
 Base pay

Base pay (also known as basic salary or base salary)

refers to the fixed financial amount that an
organization pays its employees in exchange for the
services they perform. This amount is negotiated
during the hiring process and agreed upon before the
employment contract begins. It is typically an annual
or monthly salary or an hourly rate.
Salary is the most important financial compensation
tool.
Salary is the amount of money that a business pays
to an employee corresponding to the quantity and
quality of labour wasted in the process of performing
assigned work.
 Form of salary payment

Product-based salary: is a form

Time-based salary: is a salary
of pay based on the quality of
paid to employees based on the
products that workers create
ratio of wages divided by actual
and the unit wage price of the
working time.
product to pay workers.
Amounts of money that businesses pay to employees
for their achievements and contributions beyond the
level prescribed by their responsibilities. Bonuses
along with salaries create the main cash income of
employees.
 Shares ownership
Shares ownership are a form of equity compensation
that allows an employee to buy a specific number of
shares at a pre-set price. Many startups, private
companies, and corporations will include them as part
of a compensation plan for prospective employees.
Companies often offer stock options as part of your
compensation package so you can share in the
company’s success.
 Allowances
An allowance is an additional amount of money paid
to employees because they take on additional
responsibilities or work under unusual conditions.
Allowances have the effect of creating fairness in
actual compensation. Businesses can have
allowances such as:
- Work responsibility allowance
- Dangerous toxic allowance
- Regional allowance
- Attractive allowance
- Mobility allowance,...
 Non-financial compensation

Non-financial compensation is a type of employee benefit that

holds no inherent monetary value. There are many types of
non-financial compensation that employers can choose to
provide employees—ranging from ones that provide
convenience to ones that ensure overall health and wellness.
If you're searching for roles, it may be helpful to learn more
about non-financial compensation when comparing positions.
In this article, we define non-financial compensation, describe
its different types, compare it to direct and indirect
compensation and discuss its benefits.
 Developmental opportunities
Employers can choose to provide developmental
opportunities to employees. This can be a useful form
of non-financial compensation as it benefits both an
employer and an employee.
When an employer offers opportunities for employees
to develop their skills so they can continue to advance
within the company, an employer also benefits from
possessing more motivated and skilled employees.
 Recognition
Many employees prefer to be recognized by their employers for
the hard work they complete. Recognizing employees lets them
know that the work they do is valuable to their employer. By
doing this, employers may experience an increase in employee
engagement, improved efficiency and greater rates of retention.
 Flexible schedules
Many employees seek flexible schedules when searching
for new roles in an attempt to prioritize a healthy work-life
balance when choosing an employer. Some employers allow
their employees to set their own schedules if it doesn't
compromise the quality of their work.
 Benefits of flexible work
arrangements
Attracting high-performing
employees

Retaining employees

Reducing absenteeism

Increasing ability to handle stress

Boosting productivity

Decreasing hiring and office costs

Encouraging a better work-life

balance
 Discounts or memberships
Because many employees spend much of their week
working within an office, some employers have decided to
ensure that the work environment they offer allows
employees to maintain healthy habits.
For example, some businesses provide on-site gyms to
employees to relieve stress and remain physically fit.
Benefits of non-financial compensation
• Non-financial compensation often benefits both an employer and
an employee for several reasons. For an employer, this form of
compensation is a great way to develop trust without spending
large sums of money.
• By compensating employees with benefits that improve an
employee's working experience, they can form and maintain
stronger relationships with their employees. In addition to saving
money, they may also experience an improvement in productivity,
which helps to generate larger profits.
 Example 1: A full-time hourly
employee in retail

Compensation Benefits

3 weeks of paid leave per year for full-

Base pay: $12 per hour (up to 40 hours
per week)
Overtime pay: $18 per hour for any
overtime worked
time employees
$200 clothing allowance
15% discount on everything in store and
online, and 25% discount after 12
months of employment
 Example 2: A salaried employee in a
large business
Compensation
Base pay: $48,000 per year (contracted as
35 working hours per week), paid in
monthly installments of $4,000
Benefits
28 days paid leave
Paid sick leave
Health insurance with Kaiser Permanente
Retirement plan (the employee can
contribute up to 10% off their salary each
month into a retirement savings account,
and the company will match this
contribution)
Parental leave of 8 weeks
50% parking discount (at specific car
parks)
Subsidized food and refreshments in the
office canteen
 Example 3: a sales employee in a
SaaS company

Compensation Benefits

Base pay: $12,000 per year (contracted as

35 working hours per week), paid in
Company phone and laptop
monthly installments of $1,000.
Transport allowance (up to $200/month)
Sales commission: A one-off commission
Flexible working options (work from home
of $250 for every customer the employee
and choose your own hours)
signs up for the company’s services
50% discount on a monthly gym
Referral bonus: A one-off bonus of $250
membership (at Planet Fitness)
for every candidate the employee refers to
the company who becomes an employee
5.3. Organizing the compensation system

Building the compensation

policy

Organizing the
compensation

Evaluate the compensation

 How to Develop Pay Systems?

1. Internal alignment
o Design an internal structure
o Establish internal equity

2. External competitiveness
o Pricing the structure
o Establish external equity

3. Employee contributions
o Design pay-for-performance plans
 Internal Alignment and External
Competitiveness - Overview
Level 5 (425-575pts) Market pay 150000

level y = 161.85x + 15767 L5 (500)

Level 4 (315-425pts)
100000

Level 3 (225-315pts) L2
(200)
Level 2 (175-225pts) HRL1I L4 (370)
50000
(150)
(150) L3
Level 1 (125-175pts)
(270)
0
Policy line 0 100 200 300 400 500 600

(Pay) Range Job evaluation point

Market Pay
Level 5
Level 1 - $48K
Level 4 Level 2 - $50K
Level 3 Level 3 - $52K
Level 2 Level 4 - $75K
Level 1 (Grade) Level 5 - $102K
 Phase #1: Internal Alignment

 Focuses on the differentials across job levels/ranks

within job families Pay

Assistant Junior Senior Engineering

Engineers Engineers Engineers Managers

 Levels/Ranks and Differentials

Hierarchical Egalitarian
 Phase #1: Internal Alignment

 Job evaluation – determination of the relative worth

of jobs within an organization
o Based on job descriptions
o Point system most commonly used
 Phase #1: Internal Structure
Example

Level/Grade 4 Project Leader (480)

Implementation Consultant (430)
Administrative Leader (390)
Level/Grade 3
Software Developer (320)
Project Support Assistant (290)
Usability Engineer (260)
Level/Grade 2
Travel coordinator (245)
Administrative Assistant II (230)
Level/Grade 1 Administrative Assistant I (145)
 Phase #1: Internal Structure
Example

Level/Grade 4 Project Leader (480)

Implementation Consultant (430)
Administrative Leader (390)
Level/Grade 3
Software Developer (320)
Project Support Assistant (290)
Usability Engineer (260)
Level/Grade 2
Travel coordinator (245)
Administrative Assistant II (230)
Level/Grade 1 Administrative Assistant I (145)
 Phase #2: External
Competitiveness
 Convert job evaluation points to a dollar amount
using market pay rates

 Collect market data

 Define your firm’s market
 Firms usually collect market pay data from consulting firms
Phase #2: External Competitiveness

Policy line

Stone (2010)
 Phase #2: External
Competitiveness
 Involves a number of decisions Market pay rates
 Internal equity vs. external equity

 Pay level policy

 Lead-match-lag
Job evaluation points
Market pay rates
Lead
Match

Lag

Job evaluation points

 Phase #2: External
Competitiveness
 Grades and ranges
(Pay)
Policy line

Maximum

Range
Midpoint

Minimum
Grade 4
Grade 3

Grade 2
Grade 1

(Grade)
Job A Job D Job G Job I
Job B Job E Job H Job J
Job C Job F
 Phase #3: Employee
Contributions
 “Pay-for-performance”

 Variety of plans
 Merit pay
 Individual incentives
 Profit sharing
 Gainsharing
 Stock ownership (e.g., share options)
Phase #3: Employee
Contributions
Factors Influencing
Compensation
Ratio of Demand and Supply

Ability to Bargain

Cost of Living

Type at Market

Comparative Wages

Ability to Pay

Labour Efficiency

Employment Skills

Government Regulations

Image of the Organisation

During one of my recent enculturation workshops, I was approached by the
manager of a company who confided in me that he had an urgent need to fix a
volatile workplace environment.
He discovered that some of his employees, mostly of the Millennial generation, were
openly sharing confidential details of their individual compensation plans with one
another. And as much as he was dismayed by the breach of employer/employee
confidentiality, he found himself struggling with a much larger issue – individual
employees were confronting him, crying foul and demanding an explanation for the
variances in compensation structures among others sharing similar titles. And, it wasn’t
just the lower-paid employees who were complaining – it was also those with premium-
level compensation packages sticking up for their counterparts.
He explained, “I’m stuck on the defensive line, and as much as I explain to these guys
that compensation packages are supposed to be confidential, and that each employee is
paid based on a variety of different factors, they either don’t care or aren’t listening. What
other people make is none of their business. It’s affecting morale and our culture is in
trouble”.
Perhaps you can empathize with this manager’s situation. Aside from the trend of
employees sharing such professionally intimate details with each other, information once
considered private and confidential is rather easy to access despite password-protected
CRMs and accounting software.
Such unintended and unwanted transparency is forcing organizations to rethink how to
onboard, train and manage employees who know too much.
Analyse the case and proposed solutions