Compensation Management

Compensation management is the practice of the organization that involves giving monetary
as well as non-monetary rewards to the employees, in order to compensate for the time they
allocate to their job. ... Compensation management involves “maximizing the return on human
capital.”

Compensation management, also known as wage and salary administration,

remuneration management, or reward management, is concerned with
designing and implementing total compensation package.

Compensation is the human resource management function that deals with

every type of reward individuals receive in exchange for performing an
organizational task.

What is Compensation and Compensation

Management?
Compensation is referred to as money and other benefits received by an
employee for providing services to his employer.

Compensation refers to all forms of financial returns: tangible services and

benefits employees receive as part an employment relationship, which may be
associated with employee’s service to the employer like provident fund,
gratuity, insurance scheme and any other payment which the employee
receives or benefits he enjoys in lieu of such payment.

According to Dale Yoder, “Compensation is paying people for work”.

“Compensation is what employees receive in exchange for their contribution

to the organization”. – Keith Davis

In the words of Edwin B. Flippo, “The function compensation is defining as

adequate and equitable remuneration of personnel for their contributions to
the organizational objectives”.
Cascio has defined compensation as follows;

“Compensation includes direct cash payments, indirect payments in the form

of employee benefits and incentives to motivate employees to strive for
higher levels of productivity”

Beach has defined wage and salary administration as follows;

“Wage and salary’ administration refers to the establishment and

implementation of sound policies and practices of employee compensation. It
includes such areas as job valuation, surveys of wages and salaries, analysis of
relevant organizational problems, development, and maintenance of wage
structure, establishing rules for administering wages, wage payments,
incentives, profit sharing, wage changes and adjustments, supplementary
payments, control of compensation costs and other related items.”

Compensation can be in the form of cash or kind. 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.

Compensation Management – Concept
An organisation’s goals or objectives can be achieved when its
employees put in their best efforts in the right direction. Hence, they
should be nurtured properly and paid well for their work,
performance, services, etc. Besides wages or salaries, organisations
provide different kinds of incentives, benefits and services to their
employees.
Money paid to employees for their work in the form of gross pay is
included under direct compensation; while benefits come under
indirect compensation and they may consist of life, accident and
health insurance, the contribution of an organisation to retirement i.e.
retirement benefits, expenses incurred for employee welfare as social
security etc.
All these things are nothing but the compensation the employees
receive in return for their contribution to their organisation. From the
viewpoint of an organisation, compensation management is a major
function. Compensation Management is one of the most important
topics in HRM. This is one area which needs all the attention as it can
have a direct impact on all others.
Every organisation requires suitable human resources to achieve its
objectives. To get the effective results, the employees must be paid and
compensated properly even though this is not the only motivator for
the employees to work. Any unjustifiable inequality or an unacceptably
low level of reward definitely causes great dissatisfaction among
employees.
Hence, sound wage and salary policies and programmes are very
essential to attract, induct, retain and develop the employees working
in the organisation in order to get the best results from them. Wage
and salary administration or compensation management is considered
as one of the vital areas of “Human Resource Management”.
Compensation Management refers to the establishment and
implementation of sound policies, programmes and practices of
employee compensation. It is essentially the application of a
systematic and scientific approach for compensating the employees for
their work in a fair, equitable and logical manner. The factors affecting
the determination of fair and equitable compensation are many and
are very complex.
Compensation Management includes various areas such as job
evaluation, surveys of wages and salary analysis of relevant
organisational problem, development of suitable wage structure,
framing of rules for administering wages and salaries, wage payment,
incentive, control of compensation cost etc. Hence, in the era of
globalisation, privatisation, liberalisation, compensation management
has become very complex and depending upon the size of the
organisation, it may be helpful to induct a specialist to handle this
specific portfolio under HRM.

Different Types of Compensation

 There are different types of compensation. Schuler identified three major
types of compensation, which are mentioned below;

1. Non-monetary Compensation.

2. Direct Compensation.

3. Indirect Compensation.

Non-monetary Compensation

It includes any benefit that an employee receives from an employer or a job

that does not involve tangible value. Examples are career development and
advancement opportunities, opportunities for recognition, as well as work
environment and conditions.

Direct Compensation

Direct Compensation comprises of the salary that is paid to the employees

along with the other health benefits.

Money is included under direct compensation. It is an employee’s base wage

which can be an annual salary or hourly wage and any performance-based pay
that an employee receives.

Direct compensation consisting of pay received in the form of wages, salaries,

bonuses, and commissions provided at regular and consistent intervals.

These include the basic salary, house rent allowances, medical benefits, city
allowances, conveyance, provident funds, etc. It also includes bonuses,
payments for holidays, etc.

Indirect Compensation

Indirect compensation can be thought of as the nonmonetary benefits an

employee gets from the organization.
 It includes everything from legally required public protection programs such
as Social Security to health insurance, retirement programs, paid leave,
childcare or moving expenses.

While benefits come under indirect compensation and may consist of life,
accident, health insurance, the employer’s contribution to retirement, pay for a
vacation, employer’s required payment for employee welfare as social security.

Rewards and recognitions, promotions, responsibility, etc., are some factors

that induce confidence in the employees and motivate them to perform
better. It also instills the faith in them that their good work is being recognized
and they can boost their career opportunities if they continue to work harder.

Objectives of Compensation Management

The basic objective of compensation management can be briefly termed as
meeting the needs of both employees and the organization.

Employers want to pay as little as possible to keep their costs low. Employees
want to get as high as possible.

Objectives of compensation management are;

1. Acquire qualified personnel.

2. Retain current employees.

3. Ensure equity.

4. Reward desired behavior.

5. Control costs.

6. Comply with legal regulations.

7. Facilitate understanding.
8. Further administrative efficiency.

9. Motivating Personnel.

10. Consistency in Compensation.

11. To be adequate.

Compensation management tries to strike a balance between these two with

specific objectives;

Acquire qualified personnel

Compensation needs to be high enough to attract applicants. Pay levels must

respond to the supply and demand of workers in the labor market since
employees compare for workers.

Premium wages are sometimes needed to attract applicants working for

others.

Retain current employees

Employees may quit when compensation levels are not competitive, resulting
in higher turnover.

Employees serve organizations in exchange for a reward. If pay levels are not
competitive, some employees quit the firm. To retain these employees’, pay
levels must be competitive with that of other employers.

Ensure equity

To retain and motivate employees, employee compensation must be fair.

Fairness requires wage and salary administration to be directed to achieving
equity.

Compensation management strives for internal and external equity.

Internal equity requires that pay be related to the relative worth of a job so
that similar jobs get similar pay.

External equity means paying workers what comparable workers are paid by
other firms in the labor market.

Reward desired behavior

Pay should reinforce desired behaviors and act as an incentive for those
behaviors to occur in the future. Effective compensation plans reward
performance, loyalty, experience, responsibility, and other behaviors.

Good performance, experience, loyalty, new responsibilities, and other

behaviors can be rewarded through an effective compensation plan.

Control costs

A rational compensation system helps the organization obtain and retain

workers reasonable cost. Without effective compensation management,
workers could be overpaid or underpaid.

Comply with legal regulations

A sound wage and salary system considers the legal challenges imposed by
the government and ensures employers compliance.

Facilitate understanding

The compensation management system should be easily understood by

human resource specialists, operating managers and employees.

Further administrative efficiency

Wage and salary programs should be designed to be managed efficiently,

making optimal use of the HRIS, although this objective should be a
secondary consideration with other objectives.
 Motivating Personnel

Compensation management aims at motivating personnel for higher

productivity.

Monetary compensation has its own limitations in motivating people for

superior performance. Besides money people also wants praise, promotion,
recognition, acceptance, status, etc. for motivation.

Consistency in Compensation

Compensation management tries to achieve consistency-both internal and

external in compensating employees. Internal consistency involves payment
on the basis of the criticality of jobs and employees’ performance on jobs.

Thus, higher compensation is attached to higher-level jobs. Similarly, higher

compensation is attached to higher performers in the same job.

To be adequate

Compensation must be sufficient so that the needs of the employee are

fulfilled substantially.

Pre-requisites for Effective Compensation

Management
An effective compensation system should fulfill the following criteria:

1. Adequate: Minimum governmental, union, and managerial pay level

positions must be met by the compensation system.

2. Equitable: Care should be taken so that each employee is paid fairly, in

line with his/her abilities, efforts, education, training, experiences,
competencies, and so on.
3. Balanced: Pay, benefits, and other rewards must provide a reasonable
compensation package.

4. Secure: Employees security needs must be adequately covered by the

compensation package.

5. Cost-Effective: Pay must be neither excessive nor inadequate,

considering what the enterprise can afford to pay.

6. Incentive Providing: The compensation package should be such that it

generates motivation for effective and productive work.

7. Acceptable to all Employees: All employees understand the pay

system well and feel it is reasonable for the enterprise and the individual.

Importance of Sound Wage Structure

A sound wage policy is to adopt a job evaluation program in order to establish
fair differentials in wages based upon differences in job contents.

Besides the basic factors provided by a job description and job evaluation,
those that are usually taken into consideration for wage and salary
administration are;

1. The organizations’ ability to pay.

2. Supply and demand of labor.

3. Prevailing market rate.

4. The cost of living.

5. The living wage.

6. Psychological and Social Factors.

7. Skill Levels Available in the Market.

1. The organizations’ ability to pay

Wage increases should be given by those organizations which can afford

them.

Companies that have good sales and, therefore, high profits tend to pay
higher those which running at a loss or earning low profits because of a higher
cost of production or low sales. In the short run, the economic influence on
the ability to pay is practically nil.

All employers, irrespective of their profits or losses, must pay no less than their
competitors and need to pay no more if they wish to attract and keep workers.
In the long run, the ability to pay is important.

2. Supply and demand of labor

If the demand for certain skills is high and supply is low, the result is a rise in
the price to be paid to these skills. The other alternative is to pay higher wages
if the labor supply is scarce and lower wages when it is excessive.

Similarly, if there is a great demand for labor expertise, wages rise; but if the
demand for manpower skill is minimal, the wages will be relatively low.

3. Prevailing market rate

This is known as the ‘comparable wage’ or ‘going wage rate’, and is the widely
used criterion.

An organization compensation policy generally tends to conform to the wage

rate payable by the industry and the community. This is done for several
reasons.

First, competition demand that competitors adhere to the same relative wage
level.

Second, various government law’s and judicial decisions make the adoption of
uniform wage rates an attractive proposition.
Third, trade union encourages this practice so that their members can have
equal pay, equal work, and geographical differences may be eliminated.

Fourth, a functionally related firm in the same industry requires essentially the
same quality of employees, with the same skill and experience. This results in a
considerable uniformity in wage and salary rates.

Finally, if the same or about the same general rates of wages are not paid to
the employees as are paid by the organizations’ competitors, it will not be
able to attract and maintain the sufficient quantity and quality of manpower.

4. Cost of living

The cost of living pay criterion is usually regarded as an automatic minimum

equity pay criterion. This criterion calls for pay adjustments based on increases
or decreases in an acceptable cost of living index.

When the cost of living increases, workers and trade unions demand adjusted
wages to offset the erosion of real wages.

5 Living wage

The living wage criterion means that wages paid should be adequate to
enable an employee to maintain himself and his family at a reasonable level of
existence.

However, employers do not generally favor using the concepts of a living

wage as a guide to wage determination because they prefer to base the wages
of an employee on his contribution rather than on his need.

6. Psychological and Social Factors

Psychologically, persons perceive the level of wages as a measure of success in

life; people may feel secure; have an inferiority complex, seem inadequate or
feel the reverse of all these. They may not take pride in their work, or in the
wages they get.
 Therefore, these things should not be overlooked by the management in
establishing wage rate.

Sociologically and ethically, people feel that “equal work should carry equal
that wages should be commensurate with their efforts, that they are not
exploited, and that no distinction is made on the basis of caste, color, sex or
religion.”

To satisfy the conditions of equity, fairness, and justice, management should

take these factors into consideration.

7. Skill Levels Available in the Market

With the rapid growth of industries business trade, there is a shortage of

skilled resources. The technological development, automation has been
affecting the skill levels at faster rates.

Thus the wage levels of skilled employees are constantly changing and an
organization has to keep its level up to suit the market needs.

Challenges or Problems of Compensation

Management
Even the most rational methods of determining pay must be tempered by
good judgment when challenges arise.

The implications of these demands may cause analysts to make further

adjustments to compensation.

1. Strategic Objectives.

2. Prevailing Wage Rates.

3. Union Power.

4. Government Constraints.
5. Comparable Worth and Equal Pay.

6. Compensation Strategies and Adjustments.

7. International Compensation Challenges.

8. Productivity and costs.

1. Strategic Objectives

Compensation management is not limited to internal and external equity. It

also can be used to further an employer’s strategy. Employee compensation
might have been initially anchored by the relative worth of jobs and the
prevailing wage rates in the local market.

2. Prevailing Wage Rates

Market forces may cause some jobs to be paid more than their relative worth.
Demographic shifts and relative supply and demand relationships affect
compensation.

3. Union Power

When unions represent a portion of the workforce, they may be able to obtain
wage rates that are out of proportion to the relative worth of the jobs.

Unions may also limit management’s flexibility in administering merit

increases since unions often argue for raises that are based on seniority and
are applied across the board equally.

4. Government Constraints

Government sets minimum wage, overtime pay, equal pay, child labor, and
record-keeping requirements. The minimum-wage and overtime provisions
require employers to pay at least a minimum hourly rate regardless of the
worth of the job.
5. Comparable Worth and Equal Pay

Beyond “equal pay for equal work” is the idea of “comparable pay for
comparable work” called comparable worth. It requires employers to pay
equal wages for jobs of comparable values.

Comparable worth is used to eliminate the historical gap between the incomes
of men and women.

6. Compensation Strategies and Adjustments

Most organizations have compensation strategies and policies that cause

wages and salaries to be adjusted.

A common strategy is to give nonunion workers the same raises that are given
to unionized employees; this often is done to prevent further unionization.

7. International Compensation Challenges

The globalization of business affects compensation management.

Compensation analysts must focus not only on equity but on competitiveness

too. The growing globalization of business also means a greater movement of
employee among countries.

As employees are relocated, compensation specialists are challenged to make

adjustments that are fair to the employee and the company while keeping
competitiveness in mind.

8. Productivity and costs

Regardless of the company or social policies, employers must make a profit to

survive. Without profits, they cannot attract enough investors to remain
competitive.

Therefore, a company cannot pay its workers more than the workers give back
to the firm through their productivity.
Compensation Management – 4 Main Functions
Compensation management’s objective is to hire competent persons,
to ensure the internal and external equity concept to improve
employee’s satisfaction and to retain these valuable human resources
or assets.
The main functions of Compensation Management are:
(1) The Equity Function
(2) The Welfare Function
(3) The Motivation Function
(4) The Retention Function.
(1) The Equity Function – It is the first and foremost important
function of compensation which ensures that the employees are fairly
paid and that their worth is appropriately compared. This function
ensures that more difficult jobs are paid more and that they are fairly
compensated in comparison to similar jobs in the market.
(2) The Welfare Function – This function is to take care of their
psychological and social need satisfaction. The employees worry about
the family, and the liability should be reduced and their self-esteem
needs should be met to allow them to work without tension or
unwanted stresses.
(3) The Motivation Function – The motivational function is to
encourage an employee to take further challenges, perform better and
develop oneself for superior positions. This function, therefore, takes
care of career plans and training and development activities.
(4) The Retention Function – Today, human resources are being
considered as a valuable asset to the organization and because of
retaining and developing the knowledge bank, the retention of
employees has become an important function of compensation
management.
HRM manager thus endeavour to take care of above functions in
managing the compensation to develop employees satisfaction and to
fulfil employer’s objective.