SESSION 11 & 12

Establishing Strategic Pay Plan, Pay for Performance and Financial

Incentives, Compensation Management
 Introduction to Compensation
• Aligning total rewards with strategy
• Equity and its impact on pay rates –
postulates that people are motivated to maintain a
balance between what they perceive as their
contributions and their rewards.
• External equity – market survey
• Internal equity – job analysis and evaluation
• Individual equity – performance appraisal and
incentive pay
• Procedural equity – communications, grievance
mechanisms, employee participation
 Job Evaluation Methods
Employers use two basic approaches for setting pay rates: market-based approaches
and job evaluation approaches

Job Evaluation:
• A systematic comparison done in order to determine the worth of one job relative
to another;

• The basic principle is: jobs that require greater qualifications, more
responsibilities, and more complex job duties should receive more pay than jobs
with lesser requirements.
A salary survey is conducted then to identify what other are paying for similar jobs;
By combining the information from job evaluation and survey, market-competitive
pay plan (one where the pay rates are equitable both internally – based on each
job’s relative value, and externally – based on what other employees are paying)
can be created

• Methods: ranking, classification, and point

A. Ranking Method
• A job description is created for each job;
• Select and group jobs: department wise or in clusters (ex. factory workers
and clerical workers)
• Select compensable factor (usually based on one factor, such as overall
“job difficulty”)
- Some employers develop their own compensable factors, while others use
most std ones. Ex. Equal Pay Act in the US uses 4 compensable factors – skills,
effort, responsibility, and working conditions; Hay consulting firm emphasizes –
know-how, problem solving skills and accountability requirements
- Walmart uses Hay’s factors
• Rank jobs: place index cards using alternation ranking method
• Combine ratings given by different experts for the jobs
• Compare current pay with what others are paying based on salary survey
• Assign a new pay scale
B. Classification (or Job Grading) Method
• Classes – raters categorize jobs into groups based on set of
rules for each group or class; Classes usually contain similar
jobs; all the jobs in each group are of roughly the same value
for pay purposes.
For eg. All “maintenance engineers” need similar level of
independent judgment, skill, and physical efforts;

• Grades – jobs similar in difficulty but otherwise different (ex.

dissimilar jobs like secretaries, mechanics, firefighters);
Example: US Federal Govt. system classifies the positions
automotive mechanic, welder, electrician, and machinist in
grade GS-10.
C. Point Method
• Job evaluation method in which a number of compensable factors
are identified and then the degree to which each of these factors is
present on the job is determined

• Identifying compensable factors

• Factors are scaled on a five point scale ranging from 1 (i.e., very
little is needed for this position) to 5 (i.e., a great deal is needed for
this position)
• Each factor is assigned a weight (how much more important is
“skill” than “experience”) so that the sum of weights for all factors
should be 100%
• Each job is then assigned a specific number of points (ex. “Packaged
Point Plan” by Hay Group) that can then be translated into specific
monetary figures (using market compensation data). Ex. 125* $300
= $37,500/-
Designing A Pay Structure
 Market Based Approach
• Particularly used by smaller firms
• Involves conducting formal or informal salary
surveys to determine what others in the
relevant labor markets are paying for
particular jobs
Contemporary Topics in Compensation
• Competency-Based Pay – where company pays for the employee’s range,
depth, and types of skills and knowledge, rather than for the job title or
responsibility he or she holds. Also called as knowledge or skill-based pay
(refer slide 15)

• Broadbanding – consolidating salary grades and ranges into just few wide
levels or “bands”, each of which contains a relatively wide range of jobs
and salary levels (refer slide 16)
Skill Matrix for One Job at British
Petroleum
REWARD SYSTEMS
 Definition of Reward Systems
• Tangible Returns: cash compensation (i.e.,
base pay, cost-of-living and merit pay, short-
term incentives, and long-term incentives);

• Intangible Returns/Relational Returns:

include recognition and status, employment
security, challenging work, and learning
opportunities.
Base Pay:
• Given in exchange for work performed;
• includes a range of values, focuses on the position and duties
performed rather than an individual’s contribution;
• usually the same for all employees performing similar duties;
• ignores differences across employees;
• differences within the base pay range may exist based on such
variables as experience and differential performance requirements.

Piecework - Piecework involves paying the worker a sum (piece rate)

for each unit he/she produces.

• Job evaluation – enables to assign an hourly wage rate to the job in

question; and standard number of minutes per unit or units per
hour need to be ascertained;
Ex. Job worth found to be Rs. 80/- per hour; with 20 units of
product X to be produced in an hour.
Piece rate = ?
Piece rate = 80/20 = Rs. 4 per unit
• Contingent or Merit Pay - Merit pay or a merit raise is any salary
increase the firm awards to an employee based on individual’s past
performance. It is different from a bonus in that it usually becomes
part of the employee’s base salary, whereas a bonus is a one-time
payment.
Example of Merit pay systems: the top 20% of employees in the
performance score distribution may receive a 10% annual increase,
whereas employees in the middle 70% of the distribution may
receive a 4% increase, and employees in the bottom 10% may
receive no increase at all.

• Cost-of-Living Adjustments (COLA) - the same percentage increase

for all employees regardless of their individual performance;
to combat the effects of inflation in an attempt to preserve the
employees’ buying power;
Allowances:
• include allowances covering housing and transportation, relocation
and education;
• typical for expatriate personnel and are popular for high-level
managers throughout the world.
• Eg.: The employer provides a car and the employee has the right to
use it both privately and for business;
OR
The employer provides a car allowance, more correctly referred to
as a travel allowance
• Other allowances can include smart phones and their monthly
charges, club and gym fees, discount loans, and mortgage subsidies.

Relational Returns:
• intangible in nature;
• include recognition and status, employment security, challenging
work, opportunities to learn, and opportunities to form personal
relationships at work;
 Incentive Pay Terminology
• Traditionally, all incentive plans are pay-for-performance
plans. They all tie employees’ pay to the employees’
performance.

• Variable pay is more specific: It is usually an incentive plan

that ties a group or team’s pay to some measure of the firm’s
(or the unit’s) overall profitability; profit-sharing plans are one
example.

• However, confusing as it may be, some experts use the term

variable pay to include incentive plans for individual
employees.
 Incentive Plans
Short-term Incentives:
• allocated based on past performance;
• incentives are not added to the base pay;
• only temporary pay adjustments based on the review period (e.g.,
quarterly or annual);
• Incentives are one-time payments and are sometimes referred to as
variable pay if they link pay to some measure of the firm’s (or unit’s)
overall profitability.
• Incentives are known in advance. By contrast, in the case of contingent
pay, in most cases, the specific value of the reward is not known in
advance;
• usually involve an attempt to motivate performance in the short term (i.e.,
quarter, year) and involve cash bonuses or specific prizes (e.g., two extra
days off)
Long-term Incentives:
• attempt to influence future performance over a longer period of time.
• Involve stock options or ownership plans
• Rationale is that when employees have personally invested in the
organization’s success, this investment is expected to translate into a
sustained high level of performance.
 Incentive for Sales People
• Salary Plan: Fixed salaries are offered by some firms. Straight salary makes
it simple to switch territories or to reassign salespeople, and it can foster
loyalty. A disadvantage is that it can constrict sales and de-motivate
potentially high-performing salespeople

• Commission Plan: Salespeople are paid for results, and only for results.
Thus, commission plans tend to attract high-performing salespeople who
see that effort clearly leads to rewards. But it may cause them to neglect
non-selling duties like servicing small accounts, cultivating dedicated
customers, and pushing hard-to-sell items.

• Combination Plan: Most companies pay salespeople a combination of

salary and commissions, usually with a sizable salary component.
Combination plans give salespeople a floor to their earnings and still
provide an incentive for superior performance.
Team and Organization Wide Incentive
Plans
Approaches to designing team incentives:
• Members are paid based on one of three team-based formulas
wherein all members receive the pay (a) earned by the highest
producer, (b) earned by the lowest producer, or (c) equal to the
average pay earned by the group.

• Set a production standard based on the final output of the group as

a whole. Finally, tie rewards to goals based on some overall
standard of group performance.

• Profit-sharing plans involve employees receiving a share of the

company’s annual profits.
• A Scanlon Plan is an incentive plan developed in 1937 by Joseph
Scanlon. The basic features of the plan include: philosophy of
cooperation (manager and employees get rid of “us” and “them”
attitude), identity (company’s mission to be understood by all),
competence (careful selection and training of employees),
involvement system (employees present suggestions), and sharing
of benefits formula (ratio of payroll costs to sales is 50%; all
employees usually share in 75% of savings).

• Other gain-sharing plans are incentive plans that engage many or

all employees in a common effort to achieve a company’s
productivity objectives and share the gains.

• At-risk pay plans put some portion of the employee’s normal pay at
risk, subject to the firm meeting its financial goals.

• Employee stock ownership plans (ESOP) are company-wide plans

in which a firm contributes shares of its own stock (or cash to
purchase the stock) to a trust. The trust is established to purchase
shares of the firm’s stock for employees.
 Executive Compensation in India
• Basic compensation elements for top executives include: base pay, short-term
incentives, long-term incentives, and executive benefits and perks. Shareholder
activism has tightened the restrictions on what companies pay top executives.

• In India, the Companies Act, 2013, requires that every listed company has to
constitute a nomination and a remuneration committee to ensure the level and
structure of compensation of top executives.
• The Companies Act, 2013, set the board framework for establishing managerial
remuneration for board level positions (managing director and full-time directors).
The total amount is capped at 11% of net profits. Any excess has to be authorized
by the shareholders in its General Body Meeting and approved by GoI, under
Schedule V of the Law. (refer chapter XIII; Schedule V Part II; Section 178; ,
Companies Act 2013)
• Publicly traded companies must also adhere to the disclosure requirements
prescribed under the Securities and Exchange Board of India (Listing Obligations
and Disclosure Requirements Regulations), 2015, whereby the ratio of
remuneration paid to each director and the median employee’s remuneration,
along with other prescribed details, must be disclosed.
Compensating Professional Employees
• Professional employees are those whose work involves the
application of learned knowledge to the solution of the employer’s
problems, such as lawyers, doctors, economists, and engineers.

• Making incentive pay decisions for professional employees can also

be challenging because such employees are usually paid well
anyway.

• Most employers use a market-pricing approach instead of job

evaluation, since it’s not easy to identify factors and degrees of
factors which meaningfully differentiate among the values of
professional work.
Thank You