Chapter Seven: Compensation
Definition: In layman's language the word 'compensation' means something, such as money,
given or received as payment for service. The word compensation may be defined as money
received in the performance of work, plus the many kinds of benefits and services that
organization provides their employee. It refers to wide range of financial and non -financial
rewards to employee for their service rendered to the organization.
It is paid in the form of wages, salaries, special allowance and employee benefits such as paid
vacation, insurance, maternity leaves, free travel facility, retirement benefits etc.
According to Wendell French," Compensation is a comprehensive term which includes wages,
salaries and all other allowance and benefits."
7.1. Importance of Compensation
Compensation can include monetary and non-monetary components. Compensation often
includes an employee's base salary and additional benefits, such as health insurance, retirement
plans and performance bonuses. The compensation packages a business offers to employees
affects the company's recruitment rate, retention rate and employee satisfaction. Several federal
laws affect the compensation that businesses offer. A business owner should understand the
importance of compensation and the prevailing laws to remain competitive in the market. The
following are the importance of compensation in the workplace:-
o Recruitment
The compensation packages that businesses offer to employees play an important role in the
company's ability to attract top talent as job candidates. Top-performing employees greatly
impact the competitiveness and productivity of a business.
o Motivation
Compensation often impacts an employee's motivation and job satisfaction, although it is not the
only factor. According to an article written by Mae Lon Ding of Personnel Systems Associates,
compensation systems positively impact a large percentage of workers' performances. Many
employees feel motivated to help their companies succeed if the employer shares its profits with
employees, such as with bonuses or profit-sharing plans. The greatest impact of money on
productivity and performance is in jobs where performance is directly related to compensation.
For example, the knowledge of receiving a bonus after achieving a certain sales quota will likely
motivate a salesperson to increase productivity.
o Retention
Retaining productive employees is critical to running a successful business. Retaining
employees saves companies money in training costs and helps maintain an efficient and,
knowledgeable workforce. Health insurance and retirement packages are benefits that many
employees desire from their employers. Companies that offer these benefits have a much better
chance of retaining workers than businesses that fail to offer benefit packages. Other ways to
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retain employees is through regular promotions, which not only provide an employee with a
higher base salary, but also the ability to take on more responsibility in the workplace.
Objectives of Compensation Planning
A sound compensation structure tries to achieve these objectives:
✓ To establish and maintain an equitable rewards system.
✓ To attract manpower in a competitive market.
✓ To control wages and salaries and labor costs by determining rate change and frequency
of increment.
✓ To maintain satisfaction of employees by exhibiting that remuneration is fair adequate
and equitable.
✓ To induce and improved performance, money is an effective motivator.
The basic purpose or objective of establishing sound compensation is to establish and
maintain an equitable rewards system.
7.2. Factors Affecting Compensation
Factors determining compensation of an employee considerable amount of guess word and
negotiation are involved. But following are the certain factors which have been extracted as
having an important bearing upon the final decision:
A. Supply and Demand of Labor: Whatever the organization produces as commodity they
desire services and it must pay a price that of workers acting in concert. If more the labor is
required, such as at war time prosperity, there will be tendency to increase the compensation;
whereas the situation when anything works to decrease the supply of labor, such as
restriction by a particular labor union, there will be a tendency to increase the compensation.
The reverse of each situation is likely to result in a decrease in employee compensation,
provided, labor union, ability to pay, productivity, government do not intervene.
B. Ability to Pay: Labor Unions have often demanded an increase in compensation on the
basis that the firm is prosperous and able to pay.
C. Management's Philosophy: Management's desire to maintain or improve moral, attract
high caliber employees, reduce turnover, and improve employees standard of living also
affect wages, as does the relative importance of a given position to a firm.
D. Legislation: Legislation related to plays a vital role in determining internal organization
practices. Various acts are prescribed by government of country for wage hours laws.
Wage-hour laws set limits on minimum wages to be paid and maximum hours to be
worked.
7.3. Employee Benefits and Service
Various Modes of Compensation
Various modes of compensation are as follows;
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A. Wages and Salary- Wages represent hourly rates of pay and salary refers to monthly rate
of pay irrespective of the number of hours worked. They are subject to annual increments.
They differ from employee to employee and depend upon the nature of jobs, seniority and
merit.
B. Incentives- These are also known as payment by results. These are paid in addition to
wages and salaries. Incentive depends upon productivity, sales, profit or cost reduction
efforts.
C. Fringe Benefits- These are given to employees in the form of benefits such as
provident fund, gratuity, medical care, hospitalization, accident relief, health insurance,
canteen, uniform etc.
D. Non- Monetary Benefits- They include challenging job responsibilities, recognition of
merit, growth prospects, competent supervision, comfortable working condition, job
sharing and flexi time.
Incentives
Incentives are monetary benefits paid to workers in line of their outstanding performance.
Incentives vary from individual to individual and from period to period for the same
individual. They are universal and are paid in every sector. It works as motivational force to
work for their performance as incentive forms the part total remuneration. Incentives when
added to salary increase the earning thus increase the standard of living. The advantage of
incentive payment are reduced supervision, better utilization of equipment, reduced scrap,
reduced lost time, reduced absenteeism and turnover & increased output.
Kinds of Incentives
Incentives can be classified under the following categories:
1. Individual and Organizational Incentives
2. Financial and Non-Financial Incentives
3. Positive and Negative Incentives
1. Individual and Organizational Incentives- according to L.G. Magginson, "Individual
incentives are the extra compensation paid to an individual for all production over a specified
magnitude which stems from his exercise of more than normal skill, effort or concentration
when accomplished in a predetermined way involving standard tools, facilities and
materials." Organizational or group incentive involve cooperation among employees,
management and union and purport to accomplish broader objectives such as an
organization-wide reduction in labor, material and supply costs, strengthening of
employee loyalty to company, harmonious management and decreased turnover and
absenteeism
Individual Incentive System
Some important these plans of incentive wage payments are as follows:
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Halsey Plan- Under this plan a standard time is fixed in advance for completing a work.
Bonus is rewarded to the worker who performs his work in less than the standard time and paid
wages according to the time wage system for the saved time.
The total earnings of the worker = wages for the actual time + bonus
Bonus = 33.5% of the time saved (standard time set on past experience)
Or bonus =50% of the time saved (standard are scientifically set)
Example: Time required to complete job (S) = 20 hours, actual time taken (T) = 15 hours, and
hourly Rate of Pay (R) = $ 1.5
1. Calculate the wages for the actual time?
Solution: Wages for the actual time = T X R
15 hours×$ 1.5 per hour = $22.5
2. Calculate the total earnings of the worker?
Solution: Total earnings of the worker = T X R+ (S-T) X R
2
15 X 1.5 + (20-15) X 1.5 = 22.5 + 3.75 = $26.25
2
In this equation $3.75 are the incentives (bonus) for saving 5 hours.
Group Incentive System is through co-partnership plan and profit sharing.
2. Financial and Non-financial Incentives- individual or group performance can be
measured in financial terms. It means that their performance is rewarded in money or cash as it
has a great impact on motivation as a symbol of accomplishment. These incentives form
visible and tangible rewards provided in recognition of accomplishment. Financial
incentives include salary, premium, reward, dividend, income on investment etc.
On the other hand, non-financial incentives are that social and psychological attraction which
encourages people to do the work efficiently and effectively. Non-financial incentive can be
delegation of responsibility, lack of fear, worker's participation, title or promotion, constructive
attitude, security of service, good leadership etc.
3. Positive and Negative Incentives- positive incentives are those agreeable factors related
to work situation which prompt an individual to attain or excel the standards or objectives
set for him, whereas negative incentives are those disagreeable factors in a work situation
which an individual wants to avoid and strives to accomplish the standards required on his
or her part. Positive incentive may include expected promotion, worker's preference,
competition with fellow workers and own record etc. Negative incentives include fear of
lay off, discharge, reduction of salary, disapproval by employer etc.
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Fringe Benefits
Employees are paid several benefits in addition to wages, salary, allowances and bonus. These
benefits and services are called 'fringe benefits' because these are offered by the employer as a
fringe. Employees of the organization are provided several benefits and services by the
employer to maintain and promote employee's favorable attitude towards the work and work
environment. It not only increases their morale but also motivate them. These provided
benefits and services forms the part of salary and are generally refereed as fringe benefits.
According to D. Belcher, " Fringe., benefits are any wage cost not directly connected with the
employees productive effort, performance, service or sacrifice". According to Werther and
Davis, "Fringe embrace a broad range of benefits and services that employees receive as part of
their total compensation, package pay or direct compensation and is based on critical job
factors and performance".
According to Cockman, Employee benefits are those benefits which are supplied by an
employer to or for the benefits of an employee and which are not in the form of wages,
salaries and time rated payments".
These are indirect compensation as they are extended condition of employment and are not
related to performance directly.
Kinds of Fringe Benefits
The various organizations offer fringe benefits that may be categorized as follows:
1. Old Age and Retirement Benefits - these include provident fund schemes, pension
schemes, gratuity and medical benefits which are provided to employee after their
retirement and during old age as a sense of security about their old age.
2. Workman's Compensation - these benefits are provided to employee if they are got
ignored or die under the working conditions and the sole responsibility is of the employer.
3. Employee Security- Regular wage and salary is given to employee that gives a feeling of
security. Other than this compensation is also given if there is lay-off or retrenchment in an
organization.
4. Payment for Time Not Worked — under this category of benefits, a worker is provided
payment for the work that has been performed by him during holidays and also for the work
done during odd shifts. Compensatory holidays for the same number in the same month are
given if the worker has not availed weekly holidays.
5. Safety and Health — under these benefit workers are provided conditions and requirements
regarding working condition with a view to provide safe working environment. Safety and
Health measures are also taken care of in order to protect the employees against unhealthy
working conditions and accidents.
6. Health Benefits — employees are also provided medical services like hospital facility,
clinical facility by the organization.
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