CHAPTER SEVEN

Employee Compensation Management

Compensation (Reward) management deals with the strategies, policies and processes required to
ensure that the contribution of people to the organization is recognized by both financial and
non-financial means. It is about the design, implementation and maintenance of reward systems
(reward processes, practices and procedures), which aim to meet the needs of both the
organization and its stakeholders. The overall objective is to reward people fairly, equitably and
consistently in accordance with their value to the organization in order to extend the achievement
of the organization’s strategic goals.
Total reward is monetary and non-monetary rewards provided by companies to attract,
motivate, and retain employees. Reward can be either intrinsic or extrinsic. Intrinsic rewards
may include praise for completing a project or meeting performance objectives. Other
psychological and social forms of compensation also reflect intrinsic type of rewards. Extrinsic
rewards are tangible and take both monetary and non-monetary forms. One tangible component
of a compensation program is direct compensation, whereby the employer provides monetary
rewards for work done and performance results achieved. Base pay and variable pay are the
most common forms of direct compensation.
 Base pay: basic compensation that an employee receives, usually as a wage or salary.
 Wages: Payments calculated directly from the amount of time worked by
employees (Blue collar workers).
 Salaries: Consistent payments made each period regardless of the number of hours
worked (white collar workers).
 Variable pay: Compensation linked directly to individual, team, or organizational
performance.
 The most common indirect compensation is employee benefits.
 Benefits: Indirect reward given to an employee or group of employee’s as part of
membership in the organization.

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Importance of Compensation Management
The most important objective of any pay system is fairness or equity. Equity is concerned with
felt justice according to natural law or right when an employee receives compensation from the
employer.
Equity only exists when a person perceives that the ratio of outcomes to inputs is in equilibrium
with respect of self and in relation to others. In general, the term equity has dimensions:
 Internal equity: it ensures equal pay for equal job, i.e. each individual’s pay is fair in comparison to
others doing the same or similar job in the organization.
 External equity: This ensures that jobs are fairly compensated in comparison to similar jobs in the
labor market.
 Attract capable employees to the organization: Every organization looks for retaining capable
employee with the organization. So for retaining an efficient employee within the organization,
he/she has to be provided with better compensation.
 Motivate them toward superior performance: If employees of an organization are provided with
better compensation, they will be motivated to exhibit superior performance. The better pay, the
better the performance.
 Retaining employee services over an extended period of time: retaining the services of an employee
with an organization is the most difficult job of HR. So, the retention of the employee’s service over a
long period of time is possible only by providing them with better compensation.
 Reward the right things to convey the right message about what is important in terms of behaviors
and outcomes.
 Develop a high-performance culture
 To protect the health of the employees and to provide safety to the employees against accidents.
 To create sound industrial relations.
 To improve and furnish the organizational image in the eyes of the public with a view to improving
its market position

Remuneration Determination Process

1. Job analysis: Job analysis results in job descriptions which lead to job specifications. A
job analysis describes the duties, responsibilities, working conditions and the
interrelationship between the jobs.

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 2. It attempts to record and analyze details concerning training, skills, required efforts,
qualifications, abilities, experience and responsibilities expected of an employee.
3. Job evaluation: The next step is the actual process of grading, rating or evaluating the job.
A job is rated in order to determine its value relative to all other jobs in the organization.
The next step is to convert the relative jobs into specific monetary values.
4. Return surveys: The actual amounts to be paid for relative jobs must be determined. This
is done by making wage or salary surveys in the area concerned. Surveys are conducted
based on what other firms are paying for similar jobs, their incentives, level of pay etc.
Such wage surveys provide useful information about differences in wage levels for
particular kinds of occupation. This can have a great influence on an organization’s
compensation policy.
5. Analyze relevant organizational problems: The organization problems should be
analyzed like relationships between certain jobs, whether the organization would recruit
new employees after revised wage structure, what will be the result of paying lower or
higher compensation etc.
6. Preparation of return structure: For this, several decisions need to be taken, such as:
a) Whether the organization wishes to pay amounts above (pay leader), below (pay
follower) or equal (on going) to the average in the industry.
b) Whether wage ranges should provide for merit increases or whether there should be
single rates.
c) The pay grades
7. Return Administration rules: The development of rules of wage administration has to
be done, after the rate ranges have been determined. Rule has to be developed to
determine, to what degree advancement will be based on length of service rather than
merit, with what frequency pay increases will be awarded, what rules will govern
promotion from one pay grade to another etc.

At the next stage, the employees are to be informed of the details of wage and salary program.
Most of the hourly paid workers are informed through the wage contract about the details of
wage program.

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 It is advisable, in the interest of the concern and the employees that the information about
salaries and ranges in the salaries of group should be made known to the employees concerned.
Finally, the employee is appraised and the wage fixed for the grade he/she is found fit.

Factors Affecting Compensation

There are number of factors that influence reward system. In general, they can be categorized
into internal and external factors.
A. External Factors: Refers to factors external to an organization. It includes the following:
 Labor market: Demand and supply of labor influence wage and salary fixation. A low
wage may be fixed when the supply of labor exceeds the demand for it. A higher wage
may be paid when the demand exceeds supply. Going rate of pay is another labor-related
factor influencing employee remuneration. Going rates are those that are paid by different
units of an industry in a locality and by comparable units of the same industry located
elsewhere. This is the only way of fixing salary and wage in the initial stages of plant
operations.
 Cost of living: This criterion matters during periods of rising prices, and is forgotten
when prices are stable or falling. The justification for cost of living as a criterion for
wage fixation is that the real wages of workers should not be allowed to be whittled down
by price increases. Inflation reduces the purchasing power of employees. At this time, for
basic pay to remain undisturbed the rise in the cost of living should be compensated.
 Labor unions: The presence or absence of labor union often determines the quantum of
wages paid to employees. Employers in non-unionized factories enjoy the freedom to fix
wages and salaries as they please. The employees of strongly unionized companies too,
have no freedom in wage and salary fixation. They are forced to yield to the pressure of
labor representatives in determining and revising pay scales.
 Labor laws: labor laws have a bearing on employee remuneration
 The economy: The state of the economy has an impact on wage and salary fixation. For
example, a depressed economy will probably increase the labor supply. This, in turn,
should serve to lower the going rate.

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B. The internal environment: Among the internal factors which have an impact on pay
structure are the company’s strategy, job evaluation, performance appraisal and the worker
himself/herself.
 The organizations’ ability to pay: Increase in wages should be given by those
organizations which can afford them. Companies that have good sales and high profits
tend to pay higher wages than those which are running at losses.
 Supply and demand of labor: If the demand for certain skills is high and the supply is
low, there will be a rise in the price to be paid for these skills. When the labor supply is
scarce, wages will be higher, and when labor supply is excessive, wages will be lower.
 Psychological and social factors: Psychologically, people perceive the level of
wages as a measure of success in life, people may feel secure, have an inferiority
complex etc. These things should not be overlooked or ignored by the management in
establishing wage rates. Sociologically people feel that “equal work should carry
equal wages”, that wages should be commensurate/equal with their efforts and that no
distinction is made on the basis of caste, color, sex or religion
 Business strategy: The overall strategy which a company pursues should determine the
remuneration to its employees. Where the strategy of the enterprise is to achieve rapid
growth, remuneration should be higher than what competitors pay. Where the strategy is
to maintain and protect current earnings, because of the declining fortunes of the
company, remuneration level needs to be average or even below average.
 Job evaluation and performance appraisal: Job evaluation helps establish satisfactory
wage differentials among jobs. Performance appraisal helps award pay increases to
employees who show improved performance.
 The employee: Several employee-related factors interact to determine his or her
remuneration. These include: performance, seniority, experience, potential and so on.
High performance is rewarded with a pay increase. Rewarding performance motivates the
employee to do better. Management prefers performance to affect pay increases but
unions view seniority as the most objective criterion for pay increases. Experience
makes an employee gain valuable insights and should therefore be rewarded.
Organizations do pay some individuals based on their potential.

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  Job needs: Jobs vary greatly in their difficulty, complexity and challenge. Some need
high levels of skills and knowledge while others can be handled by almost anyone.
Simple, routine tasks that can be done by many people with minimal skills receive
relatively low pay. On the other hand, complex, challenging tasks that can be done by
few people with high skill levels generally receive high pay.

Employee Benefits and Services

Employee benefits are indirect form of compensation that employees receive for being members
of the organization and for their position in the organization. The aims of providing employee
benefits are to maintain or improve the quality of life for employees, and also, they are aimed at
providing a level of protection and financial security to employees and their dependents in the
event that they die, become ill, or otherwise unable to work. Benefits are:
i. Pay for time not worked: Today, the cost of paid time-off represents one of the highest
benefit costs for organizations because of the large amount of time of that many employees
receive. Periods like rest periods, lunch breaks, represent times not worked that are almost
granted as part of the job. Recognized jury duty, funeral leave, sick leave, sabbatical leave
(a time period in which a person does not report to his regular job but who remains
employed with that company), maternity leave, and unemployment insurance represent
compensated times that are not worked.
ii. Vacations and holidays: Typically, an employee must meet a certain length of service
requirements, eligible for paid vacation. For example, one year service in Ethiopian case.
Also, the time allowed for paid vacations depends on the employee’s length of service.
Vacation policies of an organization may differ among categories of employees. Most
organizations allowed employees to take vacation by day or week. Some organizations
provide for accrued vacation time that is paid if an employee leaves before taking his/her
vacation. The most common paid holidays include New Year’s Day, Labor Day, Patriots’
Day, Victory Day, Memorial Day and Religious Holidays such as Christmas, Ramadan,
Eid al-Adha etc. Most organizations also provide for some pay premium when employees
must work on a holiday.

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 iii. Severance pays: is a one-time payment some employers provide when terminating an
employee. The payment may range from three- or four-days’ wages to one or more years’
salary.
iv. Insurance Benefits: It protects employees from loss of income and extra expenses
associated with job-related injuries and illness. It provides income and medical benefits to
work-related accident or disease victims or their dependents. Workers’ compensation
benefits can be either monetary or medical. Moreover, in the event of a worker’s death or
disablement, the person’s dependents are paid cash benefits based on prior earnings. The
insurance may be:
 Life Insurance is a benefit commonly available from organizations. Life insurance
a benefit plans for their employees regardless of health or physical condition.
When provided for all employees, it is called group life insurance. Most
organizations provide group life insurance.
 Health (Hospitalization, Medical and Disability) insurance is aimed at providing
protection against medical and hospitalization costs, and loss on income arising
from accidents or illness occurring from off–the-job causes. Most health insurance
plans provide, at minimum, basic hospitalization and medical insurance for all
eligible employees as a group. Most basic plans pay for hospital room and board,
surgery charges, and medical expenses.
v. Retirement benefits: Social Security provides three types of benefits:
 Retirement income at retirement age and there after
 Survivor’s or death benefits payable to the employee’s dependents regardless of age at
time of death.
 Disability benefits payable to disabled employee and their dependents. These benefits are
payable only if the employee is insured under social security Act.

Social security is paid for by a tax on the employee’s wages; employees and their employer
share equally in this tax.

vi. Education and Training Benefits: Training and education refer to the teaching or learning
activities carried on for the primary purpose of helping members of an organization to
acquire and apply the knowledge, skills abilities and attitudes needed by that organization.

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 Training and educational benefits may include: sponsorship for off duty courses, educational
leave, tuition fee, refunds and scholarship etc.
vii. Service-related employee benefits

In addition to the above-discussed benefits, organizations also provide a wide range of services
that employees find desirable. These services are usually provided by the organization at no cost
to the employee or at a significant reduction from what might have to be paid without the
organization support. Employee service is something of a general category of voluntary benefits,
including all other benefits or services provided by employers. These are such varied programs
as housing service, transportation service, cafeterias service, free parking lots, ability to purchase
company products at a discount, personal and financial counseling, legal advice, employee
assistance programs, child care and sports and recreation service. The extent and attractiveness
of these benefits vary considerably among organization. For example, purchase discounts would
be especially attractive to employees of retail or an airline
Other employee benefits
The last category of employee benefits is other employee benefits, which include other than
those already discussed in the previous tasks. These benefits usually provided as a package of
items, for example loan benefits, disablements benefits, dependent benefits, funeral benefits,
pension or provident fund and the like. Generally, benefits are offered on a take-it-or-leave-it
basis with the exception of pension schemes in which participation is usually compulsory.