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Compensation Management
Compensation Management is an organized practice that involves balancing the work-employee relation by providing monetary and non-monetary benefits to employees. Compensation includes payments such as bonuses, profit sharing, overtime pay, recognition rewards and sales commission. Compensation can also include non-monetary perks such as a company-paid car, company-paid housing and stock options. Compensation is an integral part of human resource management which helps in motivating the employees and improving organizational effectiveness.
Total compensation has three parts:
Base compensation
The fixed pay an employee receives on a regular basis, either in the form of a salary or as an hourly wage.
Pay incentive
A program designed to reward employees for good performance
Benefits:
sometimes called indirect compensation. Benefits encompass a wide variety of programs (for example, health insurance, vacations)
Importance of Compensation Management
A good compensation is must for every business organization and helps in the following way: * It tries to give proper return to the workers for their contributions to the organization. * It imparts a positive control on the efficiency of employees and encourages them to perform better and achieve the specific standards. * It forms a basis of happiness and satisfaction for the workforce that minimizes the labour turnover and confers a stable organization. * It augments the job evaluation process which in turn helps in setting up the more realistic and achievable standards. * It is designed to comply with the various labour acts and therefore does not result in disputes between the employee union and the management. This builds up a peaceful relationship between the employer and the employees. * It arouses an environment of morale, efficiency and cooperation among the workers and provides satisfaction to the workers. * It stimulates the employees to perform better and show their excellence. * Itprovides growth and advancement opportunities to the deserving employees.
Types of Compensations * Direct Compensation is typically made up of salary payments and health benefits. The creation of salary ranges and pay scales for different positions within the company are the central responsibility of compensation management staff. Direct compensation that is in line with industry standards provides employees with the assurance that they are getting paid fairly. This helps the employer avoid the costly loss of trained staff to a competitor. * Indirect Compensation focuses on the personal motivations of each person to work. Although salary is important, people are most productive in jobs where they share the company's values and priorities. These benefits can include things like free staff development courses, subsidized day care, the opportunity for promotion or transfer within the company, public recognition, the ability to effect change in the workplace, and service to others.
Components of Compensation * Wages and Salary: Wages represent hourly rates of pay, and salary refers to the monthly rate of pay, irrespective of the number of hours put in by an employee. These are subject to annual increments. * Allowances: Several allowances are paid in addition to basic pay. Some of these allowance are given below: * Dearness Allowance: This allowance is given to protect real income against inflation. Generally, dearness allowance (DA) is paid as a percentage of basic pay. * House Rent Allowance: Employers who do not provide living accommodation pay house rent allowance (HRA) to employees. This allowance is calculated as a percentage of basic pay. * City Compensatory Allowance: This allowance is paid generally to employees in metros and other big cities where cost of living is comparatively high. City compensatory allowance (CCA) is generally a fixed amount per month (30 per cent of basic pay in case of government employees). * Transport Allowance/Conveyance Allowance: Some employers pay transport allowance (TA) to their employees. A fixed sum is paid every month to cover a part of traveling charges * Incentives: Incentive compensation is performance-linked remuneration paid with a view to inspire employees to work hard and do better. Both individual incentives and group incentives are used. Bonus, profit-sharing, commissions on sales are some examples of incentive compensation * Fringe Benefits/Perquisites: These include employee benefits such as provident fund, gratuity, medical care, hospitalization, accident relief, health and group insurance, canteen, uniform, recreation and the likes.

Bonus:
The bonus can be paid in different ways. It can be fixed percentage on the basic wage paid annually or in proportion to the profitability. The Government also prescribes a minimum statutory bonus for all employees and workers. There is also a bonus plan which compensates the Managers and employees based on the sales revenue or Profit margin achieved. Bonus plans can also be based on piece wages but depends upon the productivity of labour.
Non Monetary Benefits:These benefits give psychological satisfaction to employees even when financial benefit is not available. Such benefits are: (a) Recognition of merit through certificate, etc. (b) Offering challenging job responsibilities, (c) Promoting growth prospects, (d) Comfortable working conditions, (e) Competent supervision, and (f) Job sharing and flexi-time.
Commissions:
Commission to Managers and employees may be based on the sales revenue or profits of the company. It is always a fixed percentage on the target achieved. For taxation purposes, commission is again a taxable component of compensation.The payment of commission as a component of commission is practised heavily on target based sales. Depending upon the targets achieved, companies may pay a commission on a monthly or periodical basis.
Fixed plans:
Companies may also pay employees and others a combination of pay as well as commissions. This plan is called combination or mixed plan. Apart from the salaries paid, the employees may be eligible for a fixed percentage of commission upon achievement of fixed target of sales or profits or Performance objectives. Nowadays, most of the corporate sector is following this practice. This is also termed as variable component of compensation.
Internal Versus External Equity
Fair pay is pay that employees generally view as equitable. There are two forms of pay equity.
Internal equity refers to the perceived fairness of the pay structure within a firm. External equity refers to the perceived fairness of pay relative to what other employers are paying for the same type of labor.
In considering internal versus external equity, managers can use two basic models: the distributive justice model and the labor market model.
Designing a compensation system
1. Internal Versus External Equity Will the compensation plan be perceived as fair within the company, or will it be perceived as fair relative to what other employers are paying for the same type of labor?
2. Fixed Versus Variable Pay Will compensation be paid monthly on a fixed basis—through base salaries—or will it fluctuate depending on such preestablished criteria as performance and company profits?
3. Performance Versus Membership Will compensation emphasize performance and tie pay to individual or group contributions, or will it emphasize membership in the organization—logging in a prescribed number of hours each week and progressing up the organizational ladder?
4. Job Versus Individual Pay Will compensation be based on how the company values a particular job, or will it be based on how much skill and knowledge an employee brings to that job?
5. Egalitarianism Versus Elitism Will the compensation plan place most employees under the same compensation system (egalitarianism), or will it establish different plans by organizational level and/or employee group (elitism)?
6. Below-Market Versus Above-Market Compensation Will employees be compensated at below-market levels, at market levels, or at above-market levels?
7. Monetary Versus Nonmonetary Awards Will the compensation plan emphasize motivating employees through monetary rewards like pay and stock options, or will it stress nonmonetary rewards such as interesting work and job security?
8. Open Versus Secret Pay Will employees have access to information about other workers’ compensation levels and how compensation decisions are made (open pay), or will this knowledge be withheld from employees (secret pay)?
9. Centralization Versus Decentralization of Pay Decisions Will compensation decisions be made in a tightly controlled central location, or will they be delegated to managers of the firm’s units?

THE DISTRIBUTIVE JUSTICE MODEL The distributive justice model of pay equity holds that employees exchange their contributions or input to the firm (skills, effort, time, and so forth) for a set of outcomes. Pay is one of the most important of these outcomes, but nonmonetary rewards, such as a company car, may also be significant. This social–psychological perspective suggests that employees are constantly (1) comparing what they bring to the firm to what they receive in return and (2) comparing this input/outcome ratio with that of other employees within the firm.
Employees will think they are fairly paid when the ratio of their inputs and outputs is equivalent to that of other employees whose job demands are similar to their own.
THE LABOR MARKET MODEL According to the labor market model of pay equity, the wage rate for any given occupation is set at the point where the supply of labor equals the demand for labor in the marketplace ( W 1 in Figure 10.3 ). In general, the less employers are willing to pay (lowdemand for labor) and the lower the pay workers are willing to accept for a given job (high supply of labor), the lower the wage rate for that job. 13 The actual situation is a great deal more complicated than this basic model suggests. People base their decisions about what jobs they are willing to hold on many more factors than just pay. Moreover, the pay that an employer offers is based on many factors besides the number of available people with the skills and abilities to do the job. A complete exploration of this topic is beyond the scope of this book. However, the basic point of the labor market model is that external equity is achieved when the firm pays its employees the “going rate” for the type of work they do. 14 For a growing number of managerial, professional, and technical occupations, the “going rate” is determined not only by local and domestic factors, but also by global forces. 15
In general, salary dispersion increases for higher occupational levels and for broader geographic areas. For instance, according to Salary.com in 2011 the salary range for a chief financial officer at a U.S. firm was between $168,057 (lowest 10%) and $435,833 (highest 10%). In contrast, the range for an administrative assistant is from $31,044 (lowest 10%) to $52,904 (highest 10%). 16
BALANCING EQUITY Ideally, a firm should try to establish both internal and external pay equity, but these objectives are often at odds. For instance, universities sometimes pay new assistant professors more than senior faculty who have been with the institution for a decade or more, 17 and firms sometimes pay recent engineering graduates more than engineers who have been on board for many years. 18
Many firms also have to determine which employee groups’ pay will be adjusted upward to meet (or perhaps exceed) market rates. This decision is generally based on each group’s relative importance to the firm. For example, marketing employees tend to be paid more in firms that are trying to expand their market share and less in older firms that have a well-established product with high brand recognition.
Once a decision has been made as to which groups will be adjusted upward, one difficult challenge remains: What to do with “superstars.” In some cases, these individuals command a much higher salary than the average of those holding the same title. For instance, U.S. universities are expanding their economics departments. This has driven up economics faculty salaries, which averaged more than $145,000 a year in 2011, making it one of the highest-paid
Job-Based Compensation Plans/ compensation tools
There are three key components of developing job-based compensation plans: achieving internal equity, achieving external equity, and achieving individual equity.
ACHIEVING INTERNAL EQUITY: JOB EVALUATION Job-based compensation assesses the relative value or contribution of different jobs ( not individual employees) to an organization. The first part of this process, referred to as job evaluation , is composed of six steps intended to provide a rational, orderly, and systematic judgment of how important each job is to the firm. The ultimate goal of job evaluation is to achieve internal equity in the pay structure.
Step 1: Conduct Job Analysis As we discussed in Chapter 2 , job analysis is the gathering and organization of information concerning the tasks, duties, and responsibilities of specific jobs.In this first step in the job-evaluation process, information is gathered about the duties, tasks, and responsibilities of all jobs being evaluated. Job analysts can use personal interviews with workers, questionnaires completed by employees and/or supervisors, and business records (for example, cost of equipment operated and annual budgets) to study the what, how, and why of various tasks that make up the job. Sample items from a commonly used job analysis questionnaire, the Position Analysis Questionnaire, appear in Figure 10.7 . For each question, the job analyst considers what is known about the job and decides which of the five descriptions is most appropriate.
Step 2: Write Job Descriptions In the second step in the job-evaluation process, the job-analysis data are boiled down into a written document that identifies, defines, and describes each job in terms of its duties, responsibilities, working conditions, and specifications. This document is called a job description. (You will recall this term from Chapter 2 .)
Step 3: Determine Job Specifications Job specifications consist of the worker characteristics that an employee must have to perform the job successfully. These prerequisites are drawn from the job analysis, although in some cases they are legally mandated (for example, plumbers must have a plumbing license). Job specifications are typically very concrete in terms of necessary
ACHIEVING EXTERNAL EQUITY: MARKET SURVEYS To achieve external equity, firms often conduct market surveys. The purpose of these surveys is to determine the pay ranges for each grade level. An organization may conduct its own salary surveys, but most purchase commercially available surveys. Consulting firms conduct literally hundreds of such surveys each year for almost every type of job and geographic area. Users can create customized reports based on position, job family, geographic area, industry classification, organization size, and the like using simple pull-down menus and point-and-click technology. For additional salary survey sources that are user friendly and instantly available to HR professionals and line managers via the Web, see the Manager’s Notebook, “How Much Is a Position Worth in the Marketplace?” You might want to try some of these online sources and check the salary range of a job of interest to you by state, metropolitan area, and even zip code.
ACHIEVING INDIVIDUAL EQUITY: WITHIN-PAY-RANGE POSITIONING CRITERIA After the firm has finalized its pay structure by determining pay ranges for each job, it must perform one last task: Assign each employee a pay rate within the range established for his of her job. Companies frequently use previous experience, seniority, and performance appraisal ratings to determine how much an employee is to be paid within the stipulated range for his or her job. The objective of this last step is to achieve individual equity. Individual equity refers to fairness in pay decisions for employees holding the same job.
The Legal Environment and Pay System Governance
The legal framework exerts substantial influence on the design and administration of compensation systems. The key federal laws that govern compensation criteria and procedures are the Fair Labor Standards Act, the Equal Pay Act, and the Internal Revenue Code. In addition to these, each state has its own sets of regulations that complement federal law. Labor laws may also limit managerial discretion in setting pay levels.
The Fair Labor Standards Act
The Fair Labor Standards Act (FLSA) of 1938 is the compensation law that affects most pay structures in the United States. To comply with the FLSA, employers must keep accurate records of earnings and hours worked by all covered employees and must report this information to the Wage and Hour Division of the U.S. Department of Labor. Most businesses are covered by the FLSA, except those with only one employee or annual gross sales under $500,000.
MINIMUM WAGES The federal minimum wage set by the FLSA is currently $7.25 per hour, although in some states and cities it is considerably higher. For instance, in Connecticut and Illinois the minimum wage is almost 14 percent higher ($8.25 an hour) than the federal minimum wage. Minimum wage legislation is controversial. Those in favor believe that it raises the standard of living for the poorest members of society. Those who oppose it argue that it results in higher levels of unemployment and poverty among low-skilled workers because it discourages firms from hiring and/or retaining workers. Opponents also claim that minimum wages encourage U.S. firms to open overseas plants in low-wage countries (such as Mexico and the Philippines), thereby creating more unemployment at home. This debate has not yet been resolved, probably because the minimum wage is set at a much lower level than most U.S. firms are willing to pay. However, the debate is being rekindled by a growing number of local governments passing “living wage” (wage needed to secure a decent standard of living) legislation that sets the minimum wage at a much higher level than the federal minimum of $7.25 per hour. For instance, the city of Santa Cruz, California, passed a requirement for public sector employers who contract or subcontract with the county to pay a “living wage” of $13.08 per hour, or $14.27 per hour if they do not provide benefits.

OVERTIME The FLSA requires that nonexempt employees be paid one and a half times the standard wage for each hour they work over 40 hours a week. This provision was intended to stimulate hiring by making it more costly to expand production using existing employees. In fact, however, many firms would rather pay overtime than incur the costs associated with hiring additional employees (recruitment, training, benefits, and so on). The Labor Department, requires that employers guarantee overtime for workers who earn up to $23,600 a year, up from the ceiling of $8,660 established in 1975. The change covers manual laborers, other blue-collar workers, and managers who earn $23,660 a year or less, whether they are paid salary or an hourly wage. Employers can exempt white-collar workers who make more than $23,660 from overtime pay if they do some “professional, administrative, or executive” duties or are “team leaders,” whether or not they supervise workers. 76
Overtime can make a big difference in an employee’s paycheck, and it can also derail an organization’s cost-cutting efforts. Consider, for instance, the following recent story. Like many other state employees in California, prison nurse Nellie Larot was hit last year with furloughs that cut her annual salary: It dropped $10,000, to $92,000. But she more than made up for it by working extra shifts, raking in $177,512 in overtime, according to state records. Her total $270,000 in earnings last year eclipsed the $225,000 paid to Matthew Cate, head of the entire California state prison system. Governor Arnold Schwarzenegger’s decision to furlough workers three days a month was made to save money. Ironically to make up for these lost hours and maintain minimum service, many employees who are filling the gap are taking home paychecks fattened by overtime—more than $1 billion of it last year.
The Equal Pay Act
The Equal Pay Act (EPA) was passed in 1963 as an amendment to the FLSA. As we discussed in Chapter 3 , it requires that men and women be paid the same amount of money if they hold similar jobs that are “substantially equal” in terms of skill, effort, responsibility, and working conditions. The EPA includes four exceptions that allow employers to pay one sex more than the other: (1) more seniority; (2) better job performance; (3) greater quantity or quality of production; and (4) certain other factors, such as paying extra compensation to employees for working the night shift. If there is a discrepancy in the average pay of men and women holding similar jobs, managers should ensure that at least one of the four exceptions to the EPA applies to avoid legal costs and back pay to affected employees.
COMPARABLE WORTH Equal pay should not be confused with comparable worth, a much more stringent form of legislation enacted in some countries and used in a few public jurisdictions in the United States. Comparable worth calls for comparable pay for jobs that require comparable skills, effort, and responsibility and have comparable working conditions, even if the job content is different. For instance, if a company using the point-factor job-evaluation system we described earlier finds that the administrative assistant position (held mostly by women) receives the same number of points as the shift supervisor position (held mostly by men), comparable worth legislation would require paying employees in these jobs equally, even though they might be exercising very different skills and responsibilities.
The considerable controversy surrounding comparable worth legislation centers mainly on how it should be implemented rather than on its main goal of pay equity between the sexes. Supporters of comparable worth legislation favor using job-evaluation tools to advance pay equity, pointing out that many private firms already use this method to set wages. Opponents argue that job evaluations are inherently arbitrary and that they do not take sufficient account of jobs’ market value. For example, comparable worth proponents have often said that markets treat nurses unfairly because society links the profession to women’s unpaid nurturing role in the family. Despite all the problems with implementation, comparable worth is already being used in many countries, including Britain, Canada, and Australia
Conclusion:
In recent years a great deal of attention has been directed to the development of compensation systems that go beyond just money. In particular there has been a marked increase in the use of pay-for-performance (PrP) for management and professional employees, especially for executive management and senior managers. Compensation is a primary motivation for most employees. People look for jobs that not only suit their creativity and talents, but compensate them both in terms of salary and other benefits accordingly. Adequate rewards and compensations help in attracting a quality workforce, maintaining the satisfaction of existing employees, keeping quality employees from leaving and motivating them for higher productivity.