CHAPTER 14

Compensation Administration

CHAPTER OBJECTIVES

After reading this chapter, you should be able to:

1. List the objectives, steps and challenges of compensation administration
2. Explain the elements, types and theories of compensation
3. Explain the concept of wages
4. List the kinds of pay structure
5. Elucidate the objectives of remuneration
6. List the elements and criticisms of executive compensation

As on 31 December 2008, steel conglomerate Arcelor–Mittal had nearly 316,000 employees and 66 factories in 20 countries. Its compensation strategy aims at motivating the employees towards organizational goal accomplishment, encouraging them to develop their skills and competencies continuously, retaining those who achieve performance standards and forcing the low achievers through pay-performance sensitivity to improve their performance.

Arcelor–Mittal views its employees as its most valuable assets and adopts four key steps to achieve the required production efficiency. These steps are aligning the organizational structure with the company’s goals, ensuring the right people for the right roles, succession planning and development, and effective incentive programmes. The basic elements of Arcelor–Mittal’s compensation plans are: (i) the basic salary, which is competitive with similar organizations and also in the median of the market pay range, and (ii) the above-market bonus as a reward for its employee in the years that have good results. The company also offers an Employee Share Purchase Plan (ESPP) to all its employees in different countries along with the bonus reward. To enhance the effectiveness of the compensation plans, Arcelor–Mittal ensures complete transparency and internal equity in pay fixation by adopting a group methodology in job evaluation. It also relates pay with performance to achieve the desired performance and efficiency.

Further, the executive compensation plan of Arcelor–Mittal consists of a fixed annual salary, short-term incentives like performance-related bonus, and long-term incentives such as stock options. In addition to these rewards, its executives are also eligible for perks like company cars, insurance policies, and pension plans.

Now that we have discussed the compensation schemes of one of the largest companies in the world, we shall now discuss the relevance of compensation for organizations in general.

Introduction

Compensation administration is always a vexing issue for the HR managers in the management of human resources. They always strive to develop compensation packages that satisfy the interest of both the organization and the employees. But, it is a tough and challenging task for any HR manager as there is an inherent conflict of interest between the management and the labour over the sharing of the earnings of the organization. For instance, the management’s goal is to limit the cost of production by controlling labour costs whereas the employees’ aim is to earn more from their profession. However, modern management no longer views compensation as merely a reward for the energy, expertise and time expended by the employees. It considers compensation as an effective tool to accomplish both the organizational and individual needs in a systematic and satisfactory manner. For many organizations, compensation is a vital instrument to attract and retain the best talents and motivate them to give their best for them.

Human resources are unique and precious for any organization. In fact, this is the only resource that is involved in each and every activity of an organization. Certainly, the survival and growth of an organization is critically linked to the performance and commitment of its workforce. It is, thus, necessary for the organization to keep the employees satisfied and motivated on a sustained basis. Effective compensation policies and practices constitute a major HR-oriented approach for achieving the desired level of employee morale and organizational effectiveness. The term compensation is generally a broad concept covering incentives, allowances, and benefits, besides the basic salary.

Rewarding the employees for their job efforts is the focus of the definitions of compensation. Box 14.1 lists a few of its definitions.

We may define compensation as the sum of the rewards for the job-related efforts of the employees and also for their commitment to and involvement in the job.

Objectives of Compensation Administration

Although talent attraction and retention is the primary objective of compensation administration, it also serves several other purposes. We shall now discuss the important objectives of compensation administration in detail.

Equity in Compensation

The primary objective of compensation administration is to ensure internal and external equity in the payment of salary and other benefits to the employees. Internal equity refers to the payment of equal compensation for jobs of similar nature and worth within the organization. The organization should determine the worth of each job through a job evaluation process. Through job evaluation, jobs with similar characteristics could be brought under a single job grade for the purpose of fixing the same pay grade. External equity refers to the payment of compensation to the employees at par with the wages and salary paid by similar companies for similar jobs in the industry. For this, organizations usually undertake industry-specific salary surveys in the labour market to determine the average salary offered for jobs of a similar nature.

Enhancing Individual and Organizational Efficiency

Achieving the desired level of individual and organizational efficiency is also an objective of compensation administration schemes. Every organization considers compensation as an effective instrument to fulfil the organizational goals and objectives by enhancing the productivity, performance and commitment of the employees. Organizations normally achieve the desired level of employee efficiency by including an incentive component in the compensation payable to the employees. Generally, these incentives are linked to the performance of the employees and the profitability of the organization. An organization may offer individual and/or group incentives to its employees as part of the compensation package in order to ensure effective goal accomplishment.

Employee Motivation and Retention

Retaining the existing employees is another objective of the compensation programmes. A well-designed compensation scheme motivates the employees and facilitates the retention of the best employees for a long time in the organization. In this way, it helps the organization in keeping the labour turnover and the related HR costs under control.

Goodwill in the Labour Market

Encouraging the best candidates to apply for the job vacancies and to make them accept the job offers issued by the organization after successful selection is another objective of compensation administration. Through an effective compensation policy, an organization can create a highly positive image of itself in the labour market. The goodwill created in the labour market should enable the organization to get the required number of suitable candidates with ease.

Adherence to Laws and Regulations

Complying with the prevailing laws and legislation of the country of operation is another objective of the compensation administration system. A sound compensation system would normally consider the challenges and constraints imposed by the government on compensation management. A good compensation plan would operate effectively without violating any of the legal provisions governing the computation and payment of wages and other incentives and benefits to the employees.

Controlling the HR Cost

Any compensation administration aims at keeping the HR cost well under control. Certainly, a good compensation policy would neither overpay nor underpay its employees. In fact, an effective compensation policy would reasonably satisfy the divergent needs and aspirations of both the employees and the employers.

Improving Industrial Relations

An effective compensation administration scheme intends to improve the labour–management relations in the firm. In many organizations, compensation is the major source of conflict between the management and the labour unions. However, a well-designed and transparent compensation plan would enable the organization to prove its interest in the well-being of its employees. It, thus, helps the firm in improving the employer–employee relations.

Types of Compensation

Typically, an organization provides compensation to its employees in two forms. These are: direct and indirect compensation. Depending upon its size and the compensation policy, an organization may determine the compensation packages for various categories of jobs. Small organizations usually restrict the number of components in a compensation package and also give more weightage to direct cash compensations like basic pay and variable pay. In contrast, large organizations may include several components in a compensation package. They may also offer different kinds of compensation packages for different categories of employees. We shall now discuss the direct and indirect compensations.

Direct Compensation

Direct compensation normally includes the amount payable to the employees as direct cash rewards for the work extracted from them. This may include any form of monetary benefit payable to the employee at periodic intervals. The basic pay and variable pay are the important components of direct compensation. We shall now discuss them in detail.

Basic Pay This is the basic salary received by the employee as a direct compensation for the work done by him. It is a fixed component in the compensation and it often forms the basis for the computation of variable components like bonus and other benefits. It does not usually include any incentives or allowances. The basic pay in a compensation package actually reflects the worth of a job determined through job evaluation. Generally, the compensation policy of an organization and the external labour market conditions influence the determination of the basic pay for a job.

Variable Pay This is a pay which is basically linked to the performance of the individual, group or the organization. Organizations normally offer a portion of the compensation in the form of variable pay to its employees. Variable pay may include incentives, commissions, profit-sharing, gain-sharing, and bonuses. It can be defined as an alternative compensation scheme that correlates the pay with the business results and promotes a participative management process.⁴ We shall now discuss a few components of the variable pay.

Profit-sharing—In this variable type of pay, an organization distributes a part of its profit to its employees. An important form of a profit-sharing plan is the bonus plan, in which the employees get a share of the profit at the end of the year. However, some organizations may defer the payment of the shares of profit till the expiry of a specific period. Till such time, the deferred profit share would be in the account of the employees but maintained by the company.

Gain-sharing—In gain-sharing, compensation is determined on the basis of the group or organizational performance. Normally, savings in costs, increase in quality, productivity, and customer satisfaction are the measures used for sharing the gains made by the organization.

Equity plans—Equity stock option plans (ESOPs) offered by the companies are also one of the direct compensation schemes. The purpose of ESOPs is to create an ownership interest for the employees in the organization. In this form of direct compensation, employees stand to gain from the overall performance of the organization. This can also help the employees in integrating their individual interests with the organizational interest.⁵

Indirect Compensation

Indirect compensation includes the benefits enjoyed by the employees but paid by the organization. Usually, indirect compensations are available to all the employees irrespective of their performance in the job. Mostly, the decisions relating to indirect compensation are influenced by the employees’ length of service and eligibility. Besides, indirect compensation decisions are normally guided by the policies and benefits offered by similar organizations.⁶ Typically, the components of indirect compensation are health-care schemes like Mediclaim, insurance schemes, leave travel concessions, retirement benefits and other social security schemes. An organization may also offer facilities like club membership, car, and vacation at holiday resorts as part of indirect compensation. Box 14.2 outlines the role of compensation strategy in talent attraction and retention.

The primary objective of the compensation plans is to satisfy the employees’ needs. These needs may be classified as monetary and non-monetary. The monetary needs are satisfied through direct and indirect cash compensation. The non-monetary needs are satisfied through non-monetary rewards.

Non-monetary benefits include such benefits provided by the organization to the employees that do not entail any cash expenditure. These non-monetary rewards in general help the organization in ensuring better cooperation and commitment from the employees. These may include, among others, job rotation, job-sharing, and flexi hours, e-commuting, free parking, reduced supervision, and promotions or transfers without any monetary benefits. Non-monetary benefits normally provide intrinsic satisfaction to the employees and keep up their motivation and morale.

Theories of Compensation

To gain a deeper knowledge of compensation, it is important to know a few relevant theories of compensation. We shall now see these important theories.

The Equity Theory

The equity theory is an important contribution of John Stacey Adams, a behavioural psychologist. According to this theory, ensuring a fair balance between an employee’s contributions to the job and the rewards he receives in return from that job is important for developing a mutually beneficial relationship with the employees. When the employees believe that their rewards in the form of salary, incentives, and benefits from the job are greater than their job efforts, they would be satisfied with the job. They would also be motivated adequately to perform better in their jobs. On the other hand, these employees would be frustrated and de-motivated when they believe that their contribution to the job is greater than their reward from it.

This theory traces the cause of employees’ satisfaction and dissatisfaction in the job to their perception of fairness or unfairness in the balance between their job efforts and job rewards. It is, therefore, necessary for the organization to develop a fair balance between the job efforts called input and the job rewards called output. The following illustration would highlight the working of Adams’ equity theory. Table 14.1 outlines the working of equity theory process.

The Expectancy Theory

Vroom’s expectancy theory is another important guiding factor in understanding employees’ psychology concerning work and reward. According to this theory, employees work hard in the job when they are sure of positive outcomes in the form of attractive rewards from the job. Employee motivation is the function of three factors, namely, effort, performance and outcome. Employees work with zeal when they are certain about achieving superior performance and positive outcome in the job. Thus, positive expectations about the eventual job outcomes create high employee motivation in the organization. As per this theory, an organization must constantly reinforce the belief of the employees that their efforts would get them good rewards. It should be ensured by the organization that the sincere efforts of the employees result in a high performance, which, in turn, gets them a good reward.

 

The Contingency Theory

According to this theory, different compensation strategies act equally well in different circumstances. As such, there is no single compensation strategy available for all conditions. The effectiveness of compensation strategy certainly depends on the congruence among the firm, the environment and the compensation strategies. Thus, it is possible to know the importance of compensation only when other job properties are provided.⁷ This theory can be understood better through the following example. A promising candidate, owing to family reasons (like children’s education), is not willing to leave his location (city or country). In fact, he prefers to settle in a local job even if the compensation is not rewarding. In this case, compensation becomes a secondary factor for the prospective candidate since the location of the organization becomes a primary factor. In such a situation, it is necessary for the organization to ascertain the additional monetary compensation required to persuade the prospective candidate to give priority to compensation with respect to other factors. The essence of this theory is that the importance of compensation varies from one market to another, depending upon the presence or absence of other job properties.

The Agency Theory

The agency theory views the employer as the principal and the managers as the agents. Usually, the managers never own complete responsibility for all the decisions made by them since they are not the owners of the business. Therefore, it is necessary for the organization to use compensation as an effective means for creating ownership interest among the managers. To achieve this, it is necessary to align the interest of the employees to that of the owners through unique compensation schemes. In this regard, there are various options (stock options and performance shares) available for the organization to increase the stake of the employees in its overall well-being. Finally, this theory insists that the organizations develop labour-market-oriented and performance-linked contractual relationship with the managers to motivate them constantly to achieve the organizational goals.

Compensation administration system can be classified into two kinds—behaviour-oriented system and outcome-oriented system. In the case of behaviour-oriented compensation system, employees are eligible for merit-based compensations. In contrast, the outcome-oriented compensation system provides for performance-based compensation like stock options, profit-sharing, gain-sharing and managerial commission. The agency theory supports ideally the concept of outcome-based compensation for enhancing the employees’ commitment and involvement. This theory also induces the employees to take better responsibility for their decisions. Agency compensation like employee stock options are perceived as less expensive by the organization as it does not entail any cash outlay for the firm.⁸

Concept of Wages

Wages are one of the important factors of production in any organization. It is also an important determinant of the price and profit of the product. It is, therefore, necessary to know the various wage concepts used in the determination of employee compensation. We shall now see these concepts briefly.

Real Wages

When the income earned by the employees as a reward for their job efforts is expressed in real purchasing power, it is called real wages. The actual goods and services which wages can buy constitute real wages. These real wages are usually adjusted for the prevailing rate of inflation. Any fall in real wages normally indicates the diminishing purchasing power of employees and reduced consumption. The consumer price index acts as the basis for calculating such real wages of the employees. The economic growth of the employees ultimately depends on the real wages received by them. Thus, the real wages are the indicator of the changes in the economic well-being of employees over a long period of time.

Minimum Wages

Minimum wages refer to the legally permissible minimum compensation payable to the employees for their job efforts. In India, the Minimum Wage Act, 1948, fixes the minimum rates of wages for certain jobs. The Committee Report on the Working of the Minimum Wages Act, 1948, has defined minimum wages as “the wage which must provide not only for the bare sustenance of life, but for the preservation of the efficiency of the worker too. For this purpose, the minimum wage must provide for some measure of education, medical requirements and amenities.”⁹ The purpose of minimum wages is to ensure the payment of fair wages to the employees to preserve their efficiency. The goal of providing minimum wages is to assist the employees and their families achieve self-sufficiency in life. Besides meeting the basic requirements of life like food, clothes, rent, fuel and lighting, the minimum wages should enable the employees to take care of their medical, educational and minimum recreational expenses. Since the payment of minimum wages is a statutory requirement, the organization must pay such wages, irrespective of its financial ability and the labour market conditions.

Fair Wages

Fair wages are the wages which are usually positioned above the minimum wages but below the living wages. In the case of fair wages, the organizations should not fix any wages below the minimum wages as fair wages. However, they can consider the industry’s ability to pay for determining any wages above the minimum wages. Usually, an organization considers the productivity, the location of the industry, the level of national income and the pattern of its distribution, and the wage levels prevailing in the same area for determining the fair wages. Normally, fair wages relate with fair workload and the needs of a standard family.

Living Wages

Living wages is defined by the committee on fair wages as the “highest level of wages that should enable the earner to provide for himself and his family 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, requirements of essential social needs and a measure of insurance against the more important misfortunes, including old age.”¹⁰ The purpose of living wages is to ensure that the employees get an income which is sufficient for meeting their present and future necessities and contingencies. The living wage may be described as an ideal wage for an employee as it takes care of all his needs and those of his dependents adequately. However, the living wages must be based on the national income and the ability of the industry to pay such living wages.

Pay Structure

Pay structure refers to the various levels of pay existing in an organization for different categories of jobs. An ideal pay structure creates a logically designed framework, which, in turn, facilitates the fixation of equitable and fair employee compensation.¹¹ The purpose of developing a pay structure is to achieve an effective differentiation of pay based on knowledge, skills, abilities, commitment, performance and productivity of the employees. Generally, organizations consider the job evaluation report and the conditions prevailing in the labour market while framing the pay structure. A pay structure helps in determining the promotion and succession plans of an organization. Depending upon its compensation philosophy and policies, the organization may decide whether to opt for a single pay structure or a multiple pay structure.

Kinds of Pay Structure

It is essential for an organization to have a need-based pay structure with the right mixture of flexibility and stability. An organization can choose an appropriate pay structure from the different pay structures available. We shall now discuss the kinds of pay structure briefly.

The Narrow-graded Pay Structure The narrow-graded pay structure is also called the traditional pay structure. Organizations normally have several pay grades in the pay structure. Each pay grade comprises several pay levels or scales. It consists of a group of jobs with similar internal worth and market considerations. It also has the lowest and highest limits within which the pay may be fixed for an employee. The traditional pay structure provides multiple pay-raise opportunities for the employees and also facilitates a faster pay progression from one pay grade to another.

The merit of this method is that it avoids ambiguity and ensures better clarity as each pay grade consists only of jobs with exactly equivalent worth. The limitations of this method are: (i) The presence of several pay grades might lead to difficulty in pay revisions and compensation management. (ii) There is a risk of employees reaching the peak stages of pay grades faster than they actually deserve. The narrow pay grade has been illustrated in Figure 14.1. Each pay grade in the figure consists of only three pay levels and the employees can quickly move to the next pay grade in this pay structure.

The Broad-graded Pay Structure In a broad-graded pay structure, the number of pay grades is kept to the minimum. Even if an employee gets several pay hikes in this form of pay structure, he would remain within the same pay grade for a relatively longer period of time. Usually, there would be few restrictions and conditions imposed for pay progression within a pay grade. However, the organization may enforce necessary conditions for the movement of employees from one pay grade to another. In this way, an organization can ensure better control over compensation management. Similarly, an organization can link pay rise with performance, skills and experience effectively. Figure 14.2 shows six pay levels in each pay grade, which means that the employee would move to the next pay grade only for his seventh pay hike in the existing pay grade. This structure would obviously keep the employees within a pay grade for a longer period.

The Job Family Structure The job family structure refers to the classification of jobs on the basis of discipline, occupational category, or functional areas in an organization that defines the nature and type of performed work. The organization may have distinct job families for different departments like production, marketing, finance, purchase, and research and development (R&D). Each job family can have its own set of salary ranges that are usually based on pay trends in the relevant labour market. For instance, one pay grade can be offered for the marketing department while another can exclusively deal with the R&D wing of the organization. Within each pay grade, the employees of the same department may be fixed in different pay levels, depending upon predetermined criteria like experience, education, responsibility and competencies. The number of pay levels in each pay grade may be decided on the basis of the nature of the department, the complexity of the jobs, labour market conditions, and organizational policy. Typically, a university may have distinct job families for administrative services, facilities services, information technology services, media/public relations/alumni services, research/science services, safety and security services, and student/academic services.¹² Figure 14.3 shows the pay grades for a job family structure.

The Career Family Structure A career family structure is similar to a job family structure except that the focus here is on career path and development. In the career grade, each employee gets a career progression (moves to higher pay scales) in a career hierarchy but remains within a single pay grade. Obviously, each employee would be aware of his career growth prospects in the organization and also of the financial prospects associated with his career growth. Career grades can help the organization get the best talents from the labour market because there would be clarity and firmness in the career growth and development for every position in the organization. A career grade also facilitates the decisions regarding the training and development requirements of the employees. However, it should be ensured that the progression within the career grade is based only on the requirements of the job and not on the skills and personal attributes of the employee.

Essentials of a Sound Pay Structure

A sound pay structure is critical for effective compensation management by an organization. It improves employee satisfaction, commitment, motivation and performance. It can also enhance the co-operation between the employer and the employees. We shall now see the main ingredients of an effective sound pay structure.

Alignment with the Business Objectives and Needs While determining the pay structure of the employees, it is essential to consider the objectives of the organization. These objectives are capable of providing directions to the entire business. They can also guide all the pay decisions of the organization. An organization may have specific objectives in terms of profit, customer satisfaction or expansion programmes. Different pay structures may be ideal for accomplishing different organizational objectives and needs. For instance, the marketing department may find a traditional pay structure suitable for its employees while the production department may opt for a broad-graded pay structure. The organizations may settle for a single or multiple pay structure, depending on their business needs, objectives and characteristics.

Internal Equity A sound pay structure ensures fairness and equity in the determination of pay levels for its employees. There must be equal pay for jobs of similar nature based on job evaluation. To achieve genuine equity in pay scale determination, there must be an objective evaluation of the job duties, responsibilities, difficulties and other factors connected with the job. The merit, seniority, and competencies of the employees should also be duly considered. There should be no discrimination in the fixation of pay levels on the basis of gender, caste, religion or region. The worth of the job should be the only guiding factor in deciding the pay levels and grades.

External Equity In addition to ensuring internal equity in determining the pay structure, an organization should also make certain that there is an external equity in the pay fixation. External equity ensures that the employees’ pay levels are comparable with those of employees in similar jobs in similar organizations. Pay parity with other organizations helps the organization in attracting, retaining and motivating talented employees. Organizations usually conduct salary surveys to identify the pay levels of the industry in general and the competing firms in particular. They can do a realistic assessment of the degree of external equity in the existing pay scales with the help of exit interviews and labour turnover rates. Although higher pays normally attract the best talents from the labour markets, this cannot be the only criterion for achieving external equity. This is because the employees give equal weightage to other factors like job security, organizational environment and non-monetary benefits, while deciding the degree of external equity in an organization.

Reward for the Desired Performance and Behaviour Pay levels should be fixed in such a way that they reward the employees adequately whenever they come up with the targeted performance levels and behaviour. They should also be capable of sustaining the employees’ willingness to continue with the same performance and behaviour in the future too. Similarly, there must be an in-built incentive available in the pay scale for encouraging high performance, high involvement and commitment among the employees.

Legal Compliance The pay structure of an organization must be in compliance with the prevailing laws and regulations of the country. It should also implement the recommendations of the statutory wage boards in a time-bound manner. The organization should incorporate the relevant provisions of the Minimum Wages Act 1948, Payment of Wages Act 1936, Industrial Disputes Act 1947, Equal Remuneration Act 1976, and other relevant acts in its compensation policy. Finally, since the government may impose rules and regulations from time to time, the pay structure must be flexible enough to fit in these changes in its pay structure quickly.

Reconciling Individual and Organizational Interest The pay structure should serve not only the interests of the employees but also the organizational interest. There must be due regard for the long-term interest of the organization while fixing the pay scale of the employees. The pay structure must have the capacity to attract the right employees at a reasonable cost to the organization. To reduce the financial burden of the organization, a good portion of the employees’ pay may be linked to their performance and productivity. Such an arrangement would enable the organization to control the labour cost effectively.

Factors Influencing Compensation (Wages and Salary) Administration

As illustrated in Figure 14.4, the nature and amount of compensation payable by an organization is influenced by a host of internal and external factors. But, the degree of influence of these factors might differ from one organization to another and also from one situation to another. In the globalized and intensely competitive market conditions, organizations continuously make varied efforts to achieve cost-effectiveness and need fulfilment through their compensation policies.¹³ As mentioned earlier, the factors influencing compensation administration are classified broadly into internal and external factors. The external factors influencing compensation are (i) labour market conditions, (ii) labour legislations, (iii) comparative pay scales, (iv) the cost of living, (v) the geographical location, (vi) collective bargaining, (vii) technology and (viii) globalization. The internal factors influencing compensation are (i) the capacity of the organization to pay, (ii) corporate policies and philosophy, (iii) human resource policies and strategies, and (iv) performance evaluation. We shall now see these factors in detail.

External Factors

The external factors remain outside the purview of an organization and yet influence its compensation administration. In fact, most of the factors influencing compensation administration are external. We shall now see these factors in detail.

Labour Market Conditions The difference between the demand for specific categories of employees and their supply in the labour market influences the compensation administration decisively. When the demand for labour exceeds its supply, there would be a labour shortage. In such a situation, the organizations are forced to offer higher rates of compensation to get the required number of suitable employees. This is because the people possessing the required skills would obviously demand more compensation for their services. In contrast, it would be sufficient to offer a minimum amount of compensation to employees possessing skills which are abundantly available in the labour market.

A paradoxical situation might also prevail in the labour market. On the one hand, there could be a short supply of skills which are desperately needed by the organizations. On the other hand, there could be an abundant availability of some other skills for which supply in the labour market may far exceed the organizations’ demand. Such a paradoxical situation often leads to the pampering of some sections of labour like the technical and managerial people by the organizations and the exploitation of other sections like the low-skilled and unskilled people. In manufacturing organizations, the technical jobs at managerial levels are usually offered more pay as these jobs are often in short supply in the labour market, while the non-technical ones at non-managerial levels are paid lowly because of their excess supply in the labour market.

Labour Legislations Labour laws and regulations normally have a specific influence on the wages and salary administration of an organization. Generally, the legislations enacted by the central and state governments regulate the minimum wages and bonus payable to the employees, the workloads and the working hours. Some of the important labour laws guiding organizations’ approach towards compensation payment are the Minimum Wages Act 1948, Payment of Wages Act 1936, Payment of Bonus Act 1965, Equal Remuneration Act 1976 and Payment of Gratuity Act 1972. The organizational policies concerning compensation must strictly adhere to all these and other relevant laws and regulations in force. Organizations should also comply with the recommendations of wage boards, tribunals and wage committees.

Comparative Pay Scales Organizations should consider the wages paid by similar organizations in the industry for similar jobs. When an organization pays less than the prevailing wages to its employees, its workforce strength would erode due to the high labour turnover. In contrast, when it pays more than the prevailing wages, it would be able to attract and retain the best talents. Thus, the prevailing wages critically influence the compensation policy of the organizations.

Cost of Living At times of rising prices, the cost of living emerges as a major factor in determining the salary levels of the employees. When there is an upward movement in the cost of living, the real wages decline, affecting the purchase power of the employees. Due to the changes in the cost of living, organizations usually keep a portion of the employees’ compensation (such as dearness allowance) in a variable form. The dearness allowance is fixed on the basis of the prevailing cost of living and it changes as the cost of living changes. For instance, seven major cities in India, namely, Mumbai, New Delhi, Chennai, Kolkata, Hyderabad, Pune and Bangalore, have seen a remarkable increase in the cost of living in the recent past, and this has pushed up the salary levels of the employees in these cities.¹⁴ Though the dearness allowance is linked to the cost of living, it hardly reduces even when there is a decline in the cost of living, especially in the case of government jobs.

Collective Bargaining The strength of the unions is one of the important influencing factors in compensation administration. When the unions in an organization are strong, the wage agreements are usually concluded in favour of the employees. This is because these unions exert strong pressure on the employers, both internally and externally, during wage negotiations. The unions may also ensure that the organizations strictly comply with the laws and regulations enacted by the government from time to time. In the case of non-unionized organizations, the employers enjoy more freedom in determining the wages of the employees and may tend to fix lower wages for them. However, some non-unionized organizations may fix higher wages voluntarily just to thwart the employees’ need to have unions in their organizations. Industry-level wage agreements reached through collective bargaining between the employers’ federation and the employees’ federation also has influence on the pay levels of the member-organizations.

Technology The level and sophistication of the technology available in the industry can also influence compensation administration. When the manually performed jobs are easily and effectively replaceable with the existing technology, the organization may not be inclined to offer higher wages for such jobs. When there is a skill deficit in such jobs, the organization might prefer automation rather than paying higher wages to the job holders. However, organizations may have to offer higher wages to the high-tech jobs which usually require multi-skills and technological prowess.

Geographical Location The location of the organization is also a major factor influencing compensation administration. When the organization is located in cities or urban areas, it may have to hire employees for higher wages due to the high cost of living prevailing in these areas. In contrast, the organizations located in rural or semi-urban areas may pay less to their employees, taking advantage of the low living cost in these areas.

Globalization Globalization has brought in several multinational companies to the country. The compensation policies and philosophies of these globalized companies have begun to influence and shape the HR and wages practices of the Indian companies. As a result, domestic firms are now offering several innovative compensation schemes on a par with foreign companies to attract and retain the efficient employees. Major organizations are now designing and developing global compensation strategies in a centralized manner to achieve optimum effectiveness in human resource and compensation managements. Thus, globalization also influences the compensation administration of an organization.

Internal Factors

The internal factors influencing the compensation administration are also significant in number. We shall now discuss these factors in detail.

Capacity of the Organization to Pay Organizations may have the willingness to pay more compensation to their employees but they may not have the financial ability to do so. Understandably, the financial strength of the organization is one of the highly critical factors that determine compensation administration. For instance, when the organization pays higher wages to its employees, it normally pushes up the cost of production and prices of its products. High wage cost may also impact the turnover and profitability of the organization. In such a situation, small and medium-sized organizations may not be able to afford any hike in employee salary and wages. Ironically, low wage cost may be beneficial to the firm in the short period but it may affect employee satisfaction, performance and motivation in the long term. Low wages might also cause high absenteeism and labour turnover. In a nutshell, the organization must pay wages which are not only justifiable but also within its abilities.

Corporate Policies and Philosophy Corporate philosophy, mission and vision statements provide overall directions to the entire organization and this includes its compensation administration. Organizations may deliberately pay the industry’s best wages and salary to attract and retain the high-calibre employees. Similarly, the corporate philosophy of an organization may aim at developing competitive advantage through its human resources. In such a situation, the organization may offer high financial incentives to the employees for developing their skills and competencies. Thus, the corporate philosophy and mission statements of the organization influence the compensation administration crucially.

Human Resource Policies and Strategies The HR policies of an organization which deal with various aspects of human resource management also influence compensation administration. They usually form the basis for the terms and conditions of the employment. For instance, the promotion policy which stipulates the number, nature and frequency of promotions for different categories of employees in turn influences the compensation policies of the organization. Moreover, the HR policies are revised from time to time, depending upon the developments in the environment of an organization. Such changes in HR policies bring about corresponding changes in the compensation policies of the organization.

Performance Evaluation Report Compensation administration is also influenced by performance evaluation results, job evaluation report, job description and job specification statements. The employees’ performance assessed through performance evaluation techniques may be used for determining the wage levels of the employees. Similarly, the job evaluation report can be used for fixing compensation for different jobs. The job description, which specifies the job content and context, and the job specification, which spells out the job holders’ skills and qualification, are also used for determining compensation.

Steps in Compensation Administration

The purpose of compensation administration is to compensate the employees satisfactorily and equitably and achieve the organizational goals effectively. Organizations usually develop their own compensation system for determining and computing the compensation schemes of the employees. As mentioned in Figure 14.5, an effective compensation programme involves the following steps: (i) analysis of the job, (ii) evaluation of the job, (iii) developing the pay structure, (iv) survey of wages and salary, (v) pricing of the job, and (vi) compensation revision and control. We shall now discuss these phases involved in compensation administration.

Analysis of the Job

The first step in the process of compensation administration is the analysis of the job. This should be done to determine the content and context of each job, including its duties, responsibilities and accountability. Job description, which is a written form of job analysis, is used as the basis for identifying and studying the characteristics of a job as part of compensation development measure.

Evaluation of the Job

After the jobs have been analysed on the basis of job description statements, the second phase of compensation administration involves the assessment of the worth of the jobs from the compensation perspective. An appropriate job evaluation technique is employed for ensuring internal equity in determining the compensation structure for different jobs. Job evaluation is indeed a process of evaluating the worth of the job on the basis of not only its context and content but also the necessary skills and responsibilities required for it. Organizations may employ methods like job ranking, job grading, paired comparisons, factor comparison and point ranking for evaluating the worth of the job.

Developing the Pay Structure

The pay structure determines what an individual is paid.¹⁵ Once the internal relationship among the jobs based on their relative worth has been determined, the organization determines the pay structure and pay grades for jobs of similar importance and difficulties. The organization may choose to have either the narrow-graded pay structure or the broad-graded one for compensation administration.

Survey of Wages and Salary

At this stage, an organization conducts a wages and salary survey in the labour market to gather information about the compensation provided by similar organizations in the industry for similar jobs. The primary goal of conducting a salary survey is to ensure external equity while determining the pay scale of the employees. As part of the salary survey, the organization may gather necessary information pertaining to the prevailing wage rates for the jobs in the labour market, and also information about the cost of living and inflation. Typically, an organization has two options in a salary survey. It may either conduct its own survey to know the trend in the labour market or buy the survey results of the professional agencies.

Pricing of the Job

Job pricing refers to the determination of wage rates for jobs within the organization on the basis of the job evaluation and salary survey. As part of this process, the internal worth of the job is matched with the external worth to determine the price of the job. While finalizing the compensation for jobs, the guiding principle should be ‘pay the job and reward the person’.¹⁶ Paying the job means the payment of the right wages for the job depending upon its worth, while rewarding the person refers to rewarding an individual for his efficiency assessed through performance evaluation.

Compensation Revision and Control

In many organizations, employee compensation forms a major portion of the total operating expenses. It is, therefore, necessary to develop an appropriate mechanism for monitoring the labour cost effectively. Organizations may use techniques like budgeting, performance evaluation, and other appropriate ratios like the compa ratio for determining the efficiency of compensation programmes.

Budgeting is an effective technique of controlling the financial expenditures of an organization. It also helps in monitoring, controlling and coordinating the labour cost of the organization. Budgets actually set the standards for the organization in evaluating the financial expenditure-relating employee compensation.

The Compa ratio is a relevant accounting ratio to know the present efficiency of the compensation schemes and helps in achieving the targeted efficiency in salary fixation. It facilitates the organization in knowing how close the present salary levels are to the targeted ones. This ratio helps the firm identify the mid-points in the existing pay grades, which, in turn, serve as standards for measurement of compensation efficiency. The compa ratio is calculated as follows:

Compa ratio = (average wage rate actually paid)/(mid-point range)

The range in this ratio refers to the minimum and maximum wage rates in the pay grade or classification. The mid-point refers to the exact halfway between the minimum and the maximum in a pay grade. The compa ratio is normally one.

When the result of compa ratio is more than one, it means the average salary paid by the organization in the pay grade is above the mid-point. If the target of its compensation programme is to pay the employees at the mid-point in the pay range, it should make efforts to bring down the salary levels. On the other hand, when the result of the compa ratio is less than one, it means the existing salary levels are less than the mid-point in the pay range. In such a situation, the organization may decide to either retain the salary at the same level or raise it to levels closer to the mid-point by effecting pay increases.

Challenges in Compensation Administration

Compensation administration is a highly sensitive and challenging job for the HR department. It ought to fulfil the divergent needs of both the employees and the employers justly and satisfactorily. However, organizations often face numerous challenges in developing effective compensation administration. We shall now discuss the important challenges in compensation administration.

Emergence of Innovative Job Designs

The growth of unconventional employment schemes like flexi hours, e-commuting and part-time jobs have posed new challenges to organizations in developing compensation administration. They find it difficult to develop clear, consistent compensation policies that are fair to both conventional (full-time) and unconventional jobs. For instance, they are not definite about extending the benefits available to full-time employees to other segments of employees like those in telecommuting and others. In the case of the flexi-hour system of employment, the supervisory time and the cost of supervision are exceptionally high. In such a situation, organizations would have to decide who should bear the cost of additional supervisions and other support service cost.¹⁷ All these developments pose challenges to the organizations in developing suitable compensation packages.

Relevance of Money as a Prime Motivator

A growing number of behavioural scientists are questioning the relevance of money as a motivator. According to A. Kohn, the more the money used to motivate people, the more they tend to lose interest in whatever they had to do to get the rewards.¹⁸ Thus, there is a need for the organizations to move beyond money as compensation and focus on other intrinsic factors as possible alternatives for achieving the desired employee performance, satisfaction and cooperation. However, many organizations still view monetary benefits as the only compensation for the employees’ job efforts.

Lack of Objectivity in the Fixation of Pay Structure

Many organizations are employing subjective job evaluation techniques like job ranking, job grading and paired comparison for assessing the worth of the job. This may affect the objectivity not only of the job evaluation but also of the compensation administration. This is because job evaluation forms the basis for determining the compensation plans. Consequently, imperfections in the job evaluation may result in underpaying or overpaying of jobs.

Political and Legal Challenges

Changes in the provisions of the existing laws and regulations may require corresponding changes in the compensation plans of the organization. Whenever there are amendments in the laws concerning compensation and other benefits, it becomes imperative for the organization to implement those changes. At times, this may even necessitate a complete revision in the compensation plans. Similarly, the political ideologies and philosophies of the ruling party generally determine the government’s attitude at the time of wage negotiations and industry-level collective bargaining. A labour-friendly government may pressurize the employers to concede higher benefits to the employees at the collective bargaining process. Thus, the change of government and policies affects the compensation policies of an organization.

Difficulties in Fixing Compensation for Distinct and Critical Skills

Organizations are now finding it necessary to develop tailor-made compensation packages to reward the unique and critical skills of talented employees. In a highly competitive and globalized environment, it is necessary to have highly flexible and individualized compensation plans to satisfy the reward requirements of highly skilled employees. Organizations are also under increasing pressure to develop competence-related and skill-based pay for encouraging the employees to improve their knowledge, skills and ability on a continuous basis. All these developments make compensation development and administration a much more complex task.

Balancing Organizational and Individual Needs

Organizational compensation plans must balance the needs of the organization and those of the individuals. But, from the compensation perspective, the needs of the employers and those of the employees are mutually exclusive in nature. When the employees’ monetary needs are satisfactorily addressed, it would enhance employee motivation, satisfaction and retention but it could also push up the labour cost for the organization. On the other hand, when compensation policies favour the organization, it could improve the profitability of the business and the product performance in the market. However, such a compensation policy would discourage the talented employees from remaining for long in the organization; they might quit the organization and seek better fortunes elsewhere. Thus, the compensation plans must be devised ingeniously to fulfil the needs of both the organization and the individuals.

Ethical Issues in Pay Fixation

Beyond legal compliance in compensation administration, organizations are expected to abide by the ethical probity in decisions involving compensation fixation and administration. There must be a sense of fairness in the actions of the organizations relating to compensation planning and administration. Employers are expected to stick to the standards that show a strong sense of justice and equity and also a consideration for the interest of all the employees of the organization.¹⁹ However, the unevenness in the demand for and supply of labour in the market often forces the organizations to offer exceptionally high compensations to some employees with much needed skills. In contrast, these firms offer abysmally low compensations for those skills which are abundantly available in the market and thus easily replaceable. Organizations often face ethical dilemmas while fixing compensation for employees on the basis of demand and supply in the labour market.

Executive Compensation

Executive compensation refers to the compensation package offered to the managerial personnel of an organization. The managers’ role and performance are always crucial to the survival and growth of organizations. It is, therefore, essential to offer them satisfactory compensation packages in order to attract and retain the talented executives. However, executive compensation is a matter of intense debate both inside and outside an organization. This is because the managers, especially those at the top levels, play a major role in developing their own compensation packages. Besides, executive compensation often forms a substantial portion of the total labour cost of an organization. Moreover, it is difficult to evaluate the performance efficiency of the managerial people objectively. A typical executive compensation package comprises the base pay, short-term and long-term incentives, and managerial benefits and perks.²⁰ Unlike wages and salary for workers, a major portion of the executive compensation is often tied to the performance of the company. Typically, an organization considers the extent of duties, responsibilities and risks involved in managerial positions for determining the executive pay packages.²¹ Box 14.3 outlines the system of executive remuneration fixation in Indian companies.

Objectives of Executive Compensation Packages

The driving force behind the development of executive compensation package is the organizational objectives and the human resource requirements of the business. It is essential for an organization to ensure that the compensation packages develop necessary ownership interest for the managers in the organization and also make them more responsible for their decisions. We shall now discuss all the objectives of executive compensation.

Aligning the Managerial Interest with the Ownership Interest Except the base salary, which is a fixed remuneration, the remaining components of the executive pay packages are usually variable in nature. Normally, these variable components of compensation are dependent on the organizational performance. The purpose of correlating a substantial portion of pay with the performance is to create a personal interest for the managers in the affairs of the company and to encourage them to be more sensitive to the needs of the organization.

Bringing in the Best Executives With an increased competition for talented executives in the labour market, the executive compensation plans play an important role in attracting the best talents to the company. They also help an organization retain its prized executives for a long term and protect them from possible poaching by the rival companies or by professional head-hunters.

Enhancing Employee Motivation, Involvement and Commitment The decisions of the managers can make or mar the future of an organization. Their responsibility for effective management of the business is greater than the responsibility of the non-managerial employees. Thus, there must be in-built elements in the executive compensation packages to motivate the executives on a sustained basis.

Promoting Managerial Efficiency Some of the components of an executive compensation package like managerial commission are meant directly for improving the competency and commitment of the managers. In fact, the net profit computed in financial accounts is an important indicator of the managerial efficiency. That is why managerial commissions are usually based on the net profit available to the business.

Ensuring Complete Financial Security Since managerial decisions carry considerable risk not only to the organization but also to the individual managers, it is important to offer financial security to the managers. Executive compensation must provide the necessary incentive and financial protection to the managers to encourage them to take reasonable risk in the decisions.

Encouraging Progressive Learning Executive compensation must aim at encouraging the managers to develop their skills and competencies on a continuous basis. The managers need to be up to date in their knowledge and skills in order to identify, understand and act on the challenges posed by the changes in the environment.

Elements of Executive Compensation

The major deficiency of modern-day companies is the separation of ownership and control.²² In the company form of organizations, the ownership lies with the shareholders and the control with the managers. As such, there is no incentive available for the managers to own complete responsibilities for the decisions made on behalf of the organization. To overcome such a lacuna, executive compensation plans are used creatively by the organizations to develop ownership interest for the managers in the organization. Organizations usually offer employee stock options, profit-sharing and gain-sharing schemes for linking ownership with administration and control. We shall now see these components in detail.

Basic Salary The basic salary is the key component in the compensation packages offered to the executives. Since executive compensation emphasizes more on performance-based pay and incentives, salary is usually not the major portion of these pay packages. However, the basic salary often forms the basis for computing other components. For instance, the bonus and other variable compensations like the dearness allowance are usually expressed as a percentage of only the basic pay. Similarly, pension plans and other retirement benefits are also decided only on the basis of basic salary. Prior to deciding the base salary, organizations usually undertake job evaluation exercises for assessing the internal worth of the managerial jobs. However, the base salary of top managers is largely determined through extensive salary surveys. The size of the company is also a major influencing factor in determining the salary of the managers.

Annual Bonus Plans Typically, a profit-making organization offers bonus schemes to its managers as part of the compensation package. The bonus is considered as a short-term performance-linked incentive scheme. It is computed and paid on the basis of the performance of a single year. Under a usual bonus plan, an organization may pay bonus to managers when they achieve the performance standards. They may not get any bonus till they achieve those specified performance standards.

Bonus schemes can be classified on the basis of performance measures, performance standards and pay–performance relationship structure.²³ Organizations may use one or more performance measures for determining bonus. However, accounting profits (like EBIT, revenue growth and operating income) invariably form an important financial measure. Organizations may also use non-financial performances like goal accomplishments by the managers as the basis for determining bonus plans.²⁴ For the purpose of bonus computation, an organization may use various forms of performance standards like budget standards, past-year performance standards, discretionary standards (subjective standards set by the management), peer-group standards (based on performance of similar companies), and timeless standards (fixed performance standards).²⁵

Stock Option Plan It is a unique compensation plan in which the managerial personnel get the right to buy the stocks (mostly equity shares) of their company in the future at a price which may be equal or less than the price prevailing at the time of purchase. The stock option is normally a non-tradable long-term incentive available to the managers. However, the option to buy stock would normally lapse when the executive leaves the organization for any reasons.

As discussed earlier, the stock option is an effective executive compensation scheme available to the organization to create ownership interest for the managerial personnel. The purpose of the stock option is to encourage the managers to accept increased responsibility for their decisions involving the future of the organization. The stock option is an effective motivational instrument for managers if there is a continuous increase in share prices. In contrast, it may not be as effective when there is a declining trend in the share prices. The main advantage of this compensation scheme is that there is no direct or immediate cash outflow for the company when the manager exercises this stock option. It is also effective in ensuring the retention of efficient managers on a long-term basis.

Additional Long-Term Incentive Plans (LTIP) In addition to stock option schemes, an organization may also employ other long-term reward schemes for enhancing the performance, involvement and commitment of the executives. The aim of LTIP is to enhance the performance–pay relationship considerably. Normally, organizations impose specific performance conditions on the managers for getting long-term incentives. LTIP can be computed on the basis of the cumulative performance of managers on a multi-year cycle (typically an average of three to five years). Performance unit or share is one of the popular forms of the long-term incentive plan. As per this incentive scheme, a manager would be entitled to get specific cash or shares as the reward in the event of completing the performance targets successfully. Though long-term incentives are generally tied to the overall organizational performance, they may also be linked to group performance within the organization.²⁶

Box 14.4 outlines the role of LTIP in enhancing employee performance.

Managerial Commission Commission pay is emerging as one of the important components of executive compensation packages. It is an annual performance–based incentive scheme. The commission payable to managerial people is viewed as an important technique in achieving the required level of motivation, involvement, and efficiency among managers. The primary purpose of managerial commission is to encourage the managers to keep the expenses under control and improve sales income. The commission payable to managers is normally computed in two ways. These are: commission payable on profit before charging such a commission, and commission payable on profits after charging such a commission. The ratios for these managerial commissions are:

Commission payable on net profits before charging such a commission

= Net profit × Rate of commission/100

and

Commission on net profits after charging such a commission

= Net profit × Rate of commission/(100 + Rate of commission)

Regarding managerial commission, the Companies Act 1956 states as follows: “Subject to the provisions of Section 198 and Section 309, a company having profits in a financial year may pay any remuneration, by way of salary, dearness allowance, perquisites, commission and other allowances, which shall not exceed five per cent of its net profits for one such managerial person, and if there is more than one such managerial person, ten per cent for all of them together.”²⁷

Executive Perks It is a unique kind of benefit payable to the top managers as recognition for their contribution to the growth of the organization. An important prerequisite for deciding executive perks is determining the job worth of the executives. Usually, executive perks are allowed to a select group of key executives. Normally, executive perks involve, among others, luxurious residential apartments, company cars, special parking space at office, private dining rooms, membership in country clubs, sponsored vacation trips, interest-free loans, insurance schemes and annual health examination. In addition to providing perquisites to individual executives, organizations may also extend some of these facilities to their family members, for example, reimbursement of children’s educational expenses and spouse travel. Some organizations use executive perks to let the executives stay connected to the office. For this, they provide laptops, cell phones and computers to its executives.

Criticisms of Executive Compensation

Executive compensation packages are surrounded by many controversies. Most of them revolve around the mode and quantum of payment to the senior managers. In fact, several countries, including India, have enacted specific legislations to limit the compensation payable to the top managers of the companies. We shall now discuss the merits and demerits of executive compensation from different perspectives.

Complaints of Over-payments A common complaint is that of the top managers getting a pay excessive for their performance and disproportionate to the duties and responsibilities associated with the job. That companies are usually more generous in rewarding the managers than their workers is another charge against executive compensation. Critics complain that the executive compensations grow much faster than the non-executive compensations available for ordinary workers.²⁸

However, there are several factors which support the cause of executives and justify the payment of higher compensation to them. These are:

• The nature of executive jobs is such that the managers often undertake risk by taking decisions relating to an uncertain and unknown future. Their decision may affect the future not only of the organization but that of themselves in the organization. Thus, they are justified in their demand for adequate reward for the risk involved in the managerial job.
• Compensating the highly qualified and skilled managerial people obviously requires payment of hefty compensation to these employees. When the organizations fail to respond positively and adequately to the demands of competent people, they may lose to their rivals in the competition for the services of capable executives in the labour market.
• As regards executive retention, companies often face the prospect of their highly competent managers being lured and eventually poached by the competitors. They usually prevent such a situation by offering attractive short- and long-term incentives.

These factors necessitate the development of the best executive compensation packages to attract and retain the talented executives.

Undue Influence on Compensation Determination Another criticism levelled against executive compensation is the role of top managers in the process of determining their own compensation packages. Usually, a compensation committee is nominated by the board of directors to develop compensation packages for the managers. Some critics believe that these compensation committees are unduly influenced by the top managers in the process of fixation of executive perks. This criticism is not true in majority of the cases since many compensation committees tie a large portion of the executive compensation to the organizational and individual performance goals.

Disregard for the Financial Health of the Organization One more complaint against executive compensation is that there is a disregard for the financial health of the organization while determining the incentives, bonus and perks for the managers. Critics argue that the top managers must get generous rewards only when the company has done well. Now, as mentioned earlier, most of the executive compensation elements are connected only to the organizational performance. It is thus apparent that the top managers would be eligible for attractive rewards only when the company succeeds.

Secrecy Shrouding Executive Compensation Since many organizations reward their managers mainly through executive perks and other not-so-visible schemes, critics complain that there is no transparency in the development and execution of executive compensation packages. They claim that many benefits and perks in compensation are hidden benefits and, therefore, need to be valued appropriately. In reality, specific provisions are available in existing laws like the Companies Act of 1956, to regulate the managerial remuneration payable to the employees.

Inequality of Incomes in the Organization From a macro-level economic perspective, executive compensation packages are often criticized as ignoring the share of workers in the wealth and prosperity of an organization. Critics point out that this often leads to the uneven and unjust distribution of income within the organization. However, organizations normally provide due share in the organization’s profit to the workers by declaring a certain percentage of profits as annual bonuses to employees.

Exorbitant Exit Fees The Golden Parachute Scheme is a unique executive compensation plan in which a top executive is eligible for a severance pay in the event of his present company being taken over by some other company as part of a merger plan. Severance pay may also be paid to managers when their services are terminated for other reasons. Critics, however, complain that the top managers often get exorbitant exit fees for leaving the organization. They also complain that the top managers often block important merger-and-acquisition proposals in order to extract huge exit fees from the company. However, the severance pay normally forms part of retirement benefits, which are to be duly approved by the competent authorities.

Summary

1. Compensation is the sum of rewards for the job-related efforts of the employees and for their commitment and involvement in the job.
2. The objectives of compensation administration are (i) equity in compensation, (ii) enhancing individual and organizational efficiency, (iii) employee motivation and retention, (iv) goodwill in the labour market, (v) adherence to laws and regulations, (vi) controlling HR cost, and (vii) improving industrial relations.
3. Compensation can be classified as direct and indirect compensation. The elements of direct compensation are basic and variable pay, which includes profit-sharing, gain-sharing and equity plans. Compensation can also be classified as monetary and non-monetary.
4. The types of theories of compensation are equity theory, expectancy theory, contingency theory and agency theory.
5. The basic concepts in wages are real wages, minimum wages, fair wages and living wages.
6. The kinds of pay structures are narrow-graded pay structure, broad-graded structure, job family structure and career family structure.
7. The essentials of a sound pay structure are aligning with the business objectives and needs, internal equity, external equity, rewarding the desired performance and behaviour, legal compliance, and reconciling individual and organizational interest.
8. The external factors influencing compensation are (i) labour market conditions, (ii) labour legislation, (iii) comparative pay scales, (iv) the cost of living, (v) the geographical location, (vi) collective bargaining, (vii) technology and (viii) globalization.
9. The internal factors influencing compensation are (i) the capacity of the organization to pay, (ii) the corporate policies and philosophy, (iii) human resource policies and strategies, and (iv) performance evaluation.
10. The steps in compensation administration are (i) analysis of the job, (ii) evaluation of the job, (iii) developing the pay structure, (iv) survey of wages and salary, (v) pricing of jobs, and (vi) compensation revision and control.
11. The challenges facing compensation administration are: emergence of innovative job designs, relevance of money as a prime motivator, lack of objectivity in the fixation of pay structure, political and legal challenges in compensation administration, difficulties in fixing compensation for distinct and critical skills, balancing organizational and individual needs, and ethical issues in pay fixation.
12. Executive compensation refers to the compensation package offered to the managerial personnel of an organization.
13. The objectives of executive compensation packages are: aligning managerial interest with ownership interest, bringing in the best executives, enhancing employee motivation, involvement and commitment, promoting managerial efficiency, ensuring complete financial security, and encouraging progressive learning.
14. The elements of executive compensation are the base salary, annual bonus plans, stock option plan, long-term incentive plan (LTIP), managerial commissions, and executive perks.
15. The criticisms against executive compensation are: complaints of overpayment, undue influence on compensation determination, a disregard for the financial health of the organization, secrecy shrouding executive compensation, inequality of incomes in the organization, and Golden Parachute Schemes.

Review Questions

Essay-type questions

1. Discuss in detail the different types of compensations using relevant examples.
2. Evaluate the relevance and utility of various theories on compensation.
3. Enumerate the various kinds of pay structure with suitable examples.
4. Examine critically the factors influencing the wages and salary administration using examples.
5. Describe the different steps in a compensation administration process in detail.
6. Evaluate the challenges facing the compensation programmes in Indian companies.
7. Explain the meaning, objectives and problems of executive administration schemes.
8. Describe the various components of executive compensation packages in detail.
9. What are the various criticisms made against executive compensation plans? State how far these criticisms are true.
10. Enumerate the role of human resource managers in the development and administration of compensation programmes.
11. “Compensation must fulfil the intrinsic and extrinsic needs of the employees.” Discuss.
12. “Compensation programmes must be fair to both the employers and the employees.” Justify.

Skill-development Exercise

Objective – The objective of this exercise is to show you how to develop compensation plans that can increase employee performance and job satisfaction.

Procedure Note – The class is split into groups. Each group has (1) an HR manager, (2) two HR team members, (3) two job evaluation committee members, (4) two office-bearers of the executive staff association, and (5) two observers of the meetings. The role of the observer is to observe and report on the various aspects of the role-playing sessions.

Situation

Chitartha Life Insurance is a leading insurance company engaged in the business of providing insurance solution to the customers. The company offers a variety of insurance products like health insurance, children’s growth plan and pension plan, besides regular premium plans. The employee compensation objective of the company is to achieve optimum employee efficiency and commitment through performance-linked pay packages. It has succeeded fairly in achieving its objective through a perfect pay–performance alignment.

Chitartha’s HR policy provides for the extensive revision of the employees’ pay scales once in every five years. Due to time and resource constraints, the HR department normally undertakes separate revisions for workers and executives and completes both these revisions in two successive years. Since the HR department completed the pay revisions for the workers last year, it should complete the pay revision exercise for the executive cadres this year. Regarding executive pay revision, the management issued a few specific guidelines to the HR managers. These are: (i) compressing the number of pay grades in the pay structure, (ii) enhancing executive perks, (iii) streamlining the employee stock option (ESOP) scheme, and (iv) increasing performance-based variable components in the compensation packages.

Keeping these guidelines in the background, the HR manager begins the preparations for pay revision.

Steps in the exercise

There are three steps to the exercise:

Step 1: The HR manager meets the office-bearers of the executive staff association to ascertain their compensation needs and know their suggestions for the new executive compensation package.

Step 2: He contacts the job evaluation committee members and gathers information about the worth of the various executive positions and about the pay scales of similar positions in similar organizations in the industry.

Step 3: He convenes a meeting of his HR team to finalize the new pay scale for executives after due considerations of the relevant reports and guidelines. The revised pay structure will then be sent to the top management for approval.

Step 4: The observers analyse the performance of the members in the role-playing session and give their feedback.

Case Study

Pareek Laboratories came into existence in 1979 as a medium-sized pharmaceutical company with just two generic products and 340 employees. In a span of 30 years, it has grown astonishingly and now emerged as the second-best pharmaceutical company in the country with a sizeable presence in the global market. The company’s staff list comprises 8200 talented employees. Today, the company has twelve research centres, of which four are located abroad. It is marketing nearly 625 branded products in more than 58 countries. It has also been successful in introducing 20 products in a year on an average, which itself is an indicator of the strength of its human resources.

The top management of the company strongly believes that its highly skilled employees are responsible for its stupendous performance and growth. The company has a full-fledged HR department under the stewardship of HR Director Mr Nikesh Verma. The HR department, through sustained measures and a meticulous approach, has fostered loyalty and job involvement among the members of the company. Since its inception, the labour turnover rate of the company has been far less than the industry average, except for the past two years, including the current year.

Obviously, the company is concerned about the recent disturbing trend in the employee attrition rate, particularly at the executive levels. Since executive retention is crucial to the stability of the business, the company wants to reduce the executive turnover at the earliest before too much damage is done. Many of the serving executives have blamed the pay revision conducted two years back as responsible for this trend. In the last pay revision, the company moved from a narrow-graded pay structure to a broad-graded one. Consequently, the number of pay grades were reduced and kept to a minimum in the revised pay structure. Junior-level executives complained that they got a raw deal in the new pay grade fixation and the pay difference between their level and the higher level (middle-level executives) became unacceptably large. The executives also found fault with the job evaluation techniques followed for determining the internal worth of the jobs. They felt that the ranking method adopted in job evaluation was highly subjective and functionally erratic. The junior-level executives also alleged that the job evaluation committee had evaluated persons instead of positions at executive levels, and that was responsible for the anomalies in the pay grade allocation. They wanted the HR department to undertake a fresh and objective evaluation of jobs and reallocate pay grades on the basis of the result of a new job evaluation.

However, the HR department, which takes overall responsibility for job evaluation and pay revisions, resolutely rejected the accusations made by junior-level executives. It maintained that the job evaluations were conducted in the most objective manner. The HR people also stated that the large differences between the pay scales of junior executives and those of the middle-level ones were due to the recent increase in the duties and responsibilities of the middle-level managerial jobs and not due to any flaw in the job evaluation or pay revision process. But the junior-level managers were not prepared to accept the explanation of the HR people and kept asking for a fresh exercise to fix the worth of each job in the managerial levels and reallocate pay grades.

Now, the management is in an acute dilemma. If it concedes the request of the junior-level managers and orders a fresh job evaluation and pay grade fixation for them, it might send wrong signals to other sections of the employees and they also might seek revisions. If it does not concede their request, it may not be possible to reduce the high executive turnover. Finally, the management has instructed the HR department to come out with some plausible solutions to this serious issue.

Questions for discussion

1. Do you agree with the contention of the junior-level executives that flawed job evaluation and pay grade fixation are responsible for the labour turnover problems of the company?
2. According to you, who is to be blamed for the high level of executive attritions prevailing in the company?
3. If you were to be the HR director, how would you have responded to the criticisms of the executives?
4. What will be your suggestions to solve the present imbroglio faced by the management?

Notes

1. Terry L. Leap and Michael D. Crino, Personnel/Human Resource Management (New York: Maxwell Macmillan International Editions, 1990), p. 353.
2. Gary Dessler, Human Resource Management (Delhi: Pearson Education, 2005), p. 390.
3. R. Wayne Mondy, Human Resource Management (Upper Saddle River, NJ: Pearson Education, 2007), p. 276.
4. John G. Belcher, Jr., How to Design and Implement a Results-oriented Variable Pay System (New York: AMACOM, a division of American Management Association, 1996), p. 10.
5. Anne M. Bogardus, Human Resources Jumpstart (Alameda, CA: Sybex Inc, 2004), p. 93.
6. David Allen Baldwin, The Library Compensation Handbook: A Guide for Administrators, Librarians, and Staff (Westport, CT: Libraries Unlimited, 2003), p. 174.
7. S. Rottenberg, “The Baseball Players’ Labor Market,” Journal of Political Economy, 64 (1956): 190.
8. K. Murphy, “Explaining Executive Compensation: Managerial Power Versus the Perceived Cost of Stock Options,” University of Chicago Law Review, 69 (2002).
9. Report on the Working of the Minimum Wages Act, 1948; available at http://labourbureau.nic.in/Mini%20Wages%202k5%20Intro.htm.
10. Report on the Working of the Minimum Wages Act, 1948; available at http://labourbureau.nic.in/Mini%20Wages%202k5%20Intro.htm.
11. Michael Armstrong, Employee Reward (London: Chartered Institute of Personnel and Development, 2002), p. 204.
12. http://www.indiana.edu/~uhrs/csi/compBrochure.html.
13. Raymond F. Veilleux and Louis W. Petro, Tool and Manufacturing Engineers Handbook, Vol. 5: Manufacturing Management, 4th ed. (Dearborn, MI: Society of Manufacturing Engineers (SME), 1988), p. 10.2.
14. “Indian Cities Become Costlier: Survey,” The Financial Express, available at http://www.financialexpress.com/news/Indian-cities-become-costlier-Survey/209092/.
15. David Allen Baldwin, The Library Compensation Handbook: A Guide for Administrators, Librarians, and Staff (Westport, CT: Libraries Unlimited, 2003), p. 226.
16. Donald L. Caruth and Gail D. Handlogten, Managing Compensation (and Understanding It Too): A Handbook for the Perplexed (London: Greenwood Publishing Group, 2001), p. 18.
17. Robert T. Golembiewski, Handbook of Organizational Consultation (London: CRC Press, 2000), p. 421.
18. A. Kohn, “Beyond Bribes and Threats: How Not to Get Control of the Classroom,” NAMTA Journal, 23, no. 1 (1998): 6–61.
19. R. Bruce McAfee and Claire J. Anderson, “Compensation Dilemmas: An Exercise in Ethical Decision-making,” Developments In Business Simulation & Experiential Exercises, 22 (1995): 157.
20. Mark Meltzer and Howard Goldsmith, “Executive Compensation for Growth Companies,” Compensation and Benefits Review, (November/December 1997): 41–50.
21. Jeff London, “Severance Packages Following Disney: In Search of Board Backbone,” Directorship, 32 (March 2006): 20–22.
22. Michael C. Jensen and William H. Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” Journal of Financial Economics, 3 (1976): 305–360.
23. Kevin J. Murphy, “Executive Compensation,” (June 1999), available at http://www-rcf.usc.edu/~kjmurphy/ceopay.pdf, p. 10.
24. Kevin J. Murphy, “Executive Compensation,” (June 1999), available at http://www-rcf.usc.edu/~kjmurphy/ceopay.pdf, p. 12.
25. Kevin J. Murphy, “Executive Compensation,” (June 1999), available at http://www-rcf.usc.edu/~kjmurphy/ceopay.pdf (for more information on the kinds of performance standards, refer to http://www-rcf.usc.edu/~kjmurphy/ceopay.pdf).
26. Lance A. Berger and Dorothy R. Berger, The Compensation Handbook: A State-of-the-Art Guide to Compensation Strategy and Design, 5th ed. (New York: McGraw–Hill Professional, 2008).
27. http://www.vakilno1.com/bareacts/companies-act/SCHEDULE%20659%20-%20674/sSCXIII%20-%20671.htm.
28. Robert W. Kolb, The Ethics of Executive Compensation (Oxford: Blackwell Publishing, 2006), p. 2.