Human Resources Management

Chapter 17
Compensation Management

1. Introduction

To survive and be successful in a global economy, an organization must be competitive. A major factor underlying
organizational competitiveness is compensation. This is why, compensation management is one of the most important
functions of any organization and compensation has been an extremely important issue for both, employer and
employee. This is because money is directly or indirectly related to satisfaction of all human needs. Compensation
directly influences key outcomes like job satisfaction, talent attraction, retention, performance, skill acquisition, co-
operation etc. Thus we need to design best compensation system to align employee performance with organizational
objectives.

2. Meaning of Compensation

Compensation is the human resource management function that deals with every type of reward individuals receive in
exchange for performing organizational task. Consideration for which labor is exchanged is called compensation.
Compensation is what employees receive in exchange for their work. It is a particular kind of price, that is, the price of
labor. As any other price, remuneration is set at the point where demand curve for labor crosses the supply curve of
labor.

3. Distinctions between Wages and Salary

Experts distinguish between salary and wage. A wage is one type of compensation. It is the remuneration paid for the
service of labor in production, periodically to an employee or worker Wages form that part of cost of production, which
is attributed as compensation paid to labor. Wage usually refers to the hourly rate paid to such groups as production and
maintenance employee, who are also called blue-collar workers.

4. Terms related to Compensation

Compensation

Compensation may be defined as money received in the performance of works, plus the many kinds of benefits and
services that organizations provide their employees. Money is included under direct compensation while benefits come
under indirect compensation and may consist of life, accident, health insurance, the employer's contribution to
retirement, pay for vacation, and employer's required payment for employee welfare as social security.

Fair wage

Employer fixes this. This level of wage varies from industry to industry. The main criteria are the capacity of payment Fair
wage is the wage above the minimum wage but below the living wage Fair wage refers to wage levels and company
practices regarding wages that provide a living wage for workers while still complying with all national regulations (such
as minimum wage, overtime payments, provision of paid holidays, etc.). With a fair wage, employees should be able to
maintain a decent standard of living for themselves and their families.

Minimum Wage

The minimum wage attempts to protect employees from exploitation, allowing them to afford the basic necessities of
life. The minimum wage rate fluctuates between countries and sometimes between organizations within the country.
Minimum wage refers to the minimum amount of compensation an employee must receive for performing labor.
Minimum wages are typically established by contract or legislation by the government. As such, it is illegal to pay an
employee less than the minimum wage (The government has announced Tk 5,300 as the minimum wage for garment
workers.
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Variable wage/ pay

It is another type of direct pay link to individual, team, or organizational performance. ndividual variable pay includes
bonus, incentives, sales commission and stock options Team based variable pay consists of gainsharing, quality
improvement and cost reduction. When team is rewarded for its performance, cooperation among the members usually
increases. Organizational incentives reward people based on the performance results of the entire organization.
Organization-wide incentive includes profit sharing, ESOP, and deferred compensation.

Living wage

Living wage is one, which should enable the earner to provide for himself and his family not only the bare essentials of
food, clothing, and shelter, but also a measure of frugal comfort, including education for his children, protection against
ill health, etc. Living wage is defined by the wage that can meet the basic needs to maintain a safe, decent standard of
living within the community.

Nominal wage

Nominal wage is the wage received, which is expressed in terms of money received. Wages measured in terms of money
paid, not in terms of purchasing power.

Real wage

This is the wage or earning. (which is expressed in terms of goods and services which can be purchased from the money
received as wage This also can be obtained by dividing nominal wages by cost of living index The term real wages refers
to wages that have been adjusted for inflation or, equivalently, wages in terms of the amount of goods and services that
can be bought.

5. Components of compensation

There are many components of compensation. Major components are as follows:

A. Financial compensation

Financial compensation includes: a) Wage and salary, b) Incentives (incentive depends upon productivity, sales, profit or
cost reduction efforts), c) Fringe benefits (such as provident fund, gratuity, medical care, accident reliefs, health
insurance, canteen uniform, recreation and the like), and d) Perquisites (car, club membership, paid holiday, etc.)

B. Non-financial compensation

The non-financial compensation includes the following:

 Challenging and interesting job,

 Additional responsibility,
 Recognition (recognition leads to employee feelings of self-worth and pride in making contribution),
 Job enrichment,
 Supportive leadership and management, Comfortable and safe working environment,
 Quality of work life,
 Intellectual growth and emotional maturity, Constructive social relationships with coworkers, and
 Job sharing and flexi-time

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6. Forms of Pay or Compensation

Compensation may take many forms like base pay, merit pay, incentives, bonus, and benefits and services.

Base pay

It is the basic cash compensation that an employer pays for the work performs. Periodic adjustments to basc bay may be
made on the basis of changing in the overall cost of living or inflation. Basic pay is the normal rate for a given level of
output. The pay does not does not fluctuate like dearness allowance or bonus. It is built upon the statutory min9imum
wage, the awards of wage board and by collective bargaining

Merit pay

It is any salary increase the firm awards to an individual employee based on his or her individual performance. Merit pay
recognizes past work behaviors and accomplishments. It is different from bonus in that it usually becomes part of
employee's base pay.

Dearness allowance

In order to neutralize the high cost of living, a special allowance is given, called Dearness Allowance (DA) Various
methods are used for linking DA with the cost of living index (for example, the Consumer Price Index).

Bonus

Bonus is a sum of money or an equivalent given to an employee in addition to the employee's usual compensation.
Bonus pay is compensation over and above the amount of pay specified as a base salary or hourly rate of pay Bonus pay
is used to improve employee morale, motivation, and productivity. Individual employees may receive additional
compensation payment in the form of bonus, which is a onetime payment that does not become part of the employees'
base pay (Mathis and Jackson, 2010).

Incentives

Incentives are the pay directly tied to performance. It is a variable compensation. It may be short term or long term. It
may be individual or group. Incentive influences future behavior of employees. Incentives are one-time payment One of
the difficulties with individual incentives is that an employee may focus on what is best individually and may inhibit
performance of other individuals with whom the employee is competing Group incentive has been developed to
overcome this problem. Cooperation among the members usually increases when and organization rewards an entire
group for its performance.

Benefits and Services

Benefit is an indirect reward given to an employee and group of employees as a part of organizational membership,
regardless of performance. Benefits and services differ widely from country to country. Examples of benefits and
services are: housing, transportation and family allowance, drug counseling, cafeteria etc. Manager should customize
the benefits plan to the needs of individual employees.

7. Objectives of Compensation Management

The main objectives of remuneration of an organization are to promote competitiveness and long-term financial success
of the company, contribute to the favorable development of shareholder value and increase the commitment of the
company's key persons. The basic purpose of compensation management is to establish and maintain an equitable wage
and salary structure. It is a fact that a majority of union-management disputes relate to the question of wage payment.

10. Determinants of Pay Structure and level

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Depending on the structure and traditions of different economies around the world, wage rates will be influenced by
market, legislation, and tradition. Market forces are perhaps more dominant in the United States, while tradition, social
culture and seniority, perhaps play a greater role in Japan. In practice a number of factors interact to determine wage
levels. Some of the most influential of these are the following:

a)Employee Contribution to the Firm

Compensation can be calculated basing on employee's contribution to the company. It is difficult task to determine what
contribution a given employee makes to a product. If contributions cannot be measured directly, are there factors which
influence contributions and can they be measured? Employees' contribution to a company's success is dependent upon
factors such as time spent at work, energy and skill expended-physical, mental, emotional and social, and willingness to
cooperate. It is important to measure the foregoing factors in monetary terms.

b) Labor market condition

Where a labor market is tight or loose has a major impact on wage structures and levels. Thus, if the demand for certain
skills is high, while the supply is low, there tends to be an increase in the price paid for these skills. Conversely, if the
supply of labor is plentiful, relative to the demand for it, wages tend to decrease.

c) Skill and competence

Employee skill and competency is a big determinant of compensation in many countries. A good compensation system
must be based on "Pay for the person", which can be based on actual performance levels exhibited by the employees.
Some famous players (Messi) or Film star (Amitabh Bachchan) are paid cores of taka per week. They have mastered skill
in their area of work.

d) Legislation

As in other areas, legislation related to pay plays a vital role in determining internal organization practices. For example,
wage-hour laws set limits on minimum wages to be paid and maximum hours to be worked. In Bangladesh maximum
working hours are eight per day.

e) Collective bargaining

Collective bargaining affects two key factors: the level of wages, and the behavior of workers in relevant labor markets.
In addition to wages and benefits, collective bargaining is also used to negotiate procedures for administering pay,
procedures for resolving grievances regarding compensation decisions, and methods used to determine the relative
worth of jobs.

f) Administered wages

Representatives of labor and management set wage through the collective bargaining process. These parties have the
power and they exercise their power to determine wage rates irrespective of supply and demand factors. Both parties
must make adjustment of demand and supply of labor when wage rates are administered.

g) Productivity increases

Productivity is the output- input ratio within a time period with due consideration for quality. Wage rates must be
compatible with the overall productivity of the company. It is economically justified only when labor makes a
contribution to the productivity increase.

h) Ability to pay

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Wage increases should be based on a company's ability to pay. Employees working for highly: profitable businesses have
a greater chance of receiving higher wages than those working for less profitable firms. For example, few leading private
universities are paying more to their teachers that those of public universities, even though teachers are holding similar
positions.

i) Philosophy of management

Some owners and managers have philosophical bias toward paying their as possible, while others have a completely
opposite bias. In private sector, employees as much many owners are leading a luxurious life but they are observed to
be miser in paying to their workers.

i) Cost of living

Wage increases must be related to the cost of living index. Adjustments in wages need to be made as the index changes.
Wages and cost of living move in the same direction; they may go up and down at the same time. It is like a cloud and
sailboat moving in the same direction.

12. Non-traditional

Profit-and-revenue sharing plans A final group of plans related to compensation is characterized by some form of sharing
in profits or revenues the primary objectives of profit sharing plan are to improve productivity, recruit or retain
employees, improve product or service quality, and improve employee morale. The plans include:

A) Profit-sharing

As the name suggests, profit sharing involves the employee receiving a share of the company's profits. Employees
receive a bonus that is normally based on some percentage (eg. 10 to 30 percent) of the company's profit. The
employee's basic pay is unaffected. Sharing profits with Comployees has been used as a means of incentive
compensation. Firms, use it for my institute a group incentive for increased productivity and better employee.

B) Stock Ownership Plans

Employce stock ownership plans (ESOPs) have become popular in business firms of USA and Japan (Miller and
Christopher, 1987). It is also pursued by the few Bangladeshi business. organizations, (i.e., Beximco Group, Grameen
Phone Limited, and Singer Bangladesh Ltd). ESOPS enable employees to become owners or part owners of a company
Managers and workers see themselves as one group and the result is that everyone is highly committed and motivated
(Klein, 1988). Employees tend to be most satisfied with stock ownership when the company established its ESOP for
employee-centered reasons rather than for strategic reasons.

C) Gain Sharing It is a technique that compensates workers

based on improvements in the company's productivity Gainsharing is a bonus incentive system designed to improve
productivity through employee involvement, with the gains from "working smarter" shared between the employer and
the employees according to a predetermined formula. It includes (1) a financi measurement and feedback system to
monitor company performance and distribute gains i the form of bonuses when appropriate, and (2) a focused
involvement system to eliminate barriers to improved company performance. Gainsharing most definitely is not profit
sharing, although there are some similarities Profit

Gainsharing VS Profit-sharing

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The Difference between Gainsharing & Profit Sharing

Topics Gainsharing Profit Sharing

Purpose. To drive performance of an To share the financial success of the

organization by promoting total organization and encourage
awareness, alignment, teamwork, employee identity. with company
communication and involvement success
Application The plan commonly applies to a The plan typically applies
single facility, site, or stand-alone organization-wide, companies with
organization. multiple sites typically measure
organization-wide profitability rather
than the performance of a single site.
Measurement Payout is based on operational Payout is based on a broad financial
measures (productivity, quality, measure of the organization's
spending, and service), measures profitability.
that improve the line of site" in terms
of what employees do and how they
are compensated.
Funding Gains and resulting payouts are self- Payouts are funded through company
funded based on savings generated profits.
by improved performance.
Payment Target Payouts are made only when Payouts are typically made when
performance has improved over a there are profits, performance
historical standard or target. doesn't necessary have to show an
improvement.
Employee Eligibility Typically all employees at a site are Some employee groups may be
eligible for plan payments. excluded, such as hourly or union
employees.
Payout Frequency Payout is often monthly or quarterly. Payout is typically annual.
Many plans have a year end reserve
fund to account for deficit periods
Form of Payment Payment is cash rather than deferred Historically profit plans were
compensation. Many organizations primarily deferred compensation
pay via separate check to increase plans, organization used profit.
visibility. sharing as a pension plan. Today we
see many more cash plans.
Method of Distribution Typically employees receive the same The bonus may be a larger % of
% payout or cents per hour bonus. compensation for higher-level
employees. The % bonus may be less
for lower level employees.

15. Qualities of a good Wage Plan

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The apparent purpose of a wage plan is to remunerate employees for the work they perform. This is the one side of
story because it gives the impression that output is a function of wages alone

 Simple and easy to implement and administer.

 Managers should communicate with the employees about their needs
 Review organization's compensation package regularly. Make sure it is fair, equitable, and competitive
 Be flexible and innovative to maintain a competitive advantage.
 Union man management agreement Workers must be made to understand these plans.
 It must be acceptable to the employees.
 Easily com computed.
 There must must be minimum guaranteed payment.
 Time standard must be fixed.
 Complaints and grievance must be properly attended to.
 Earnings related to effort.
 Relatively stable and unvarying. It should not change plan frequently,

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