Module V

Compensation Management and Incentives

Mr. Kumar Satyam

Amity University Jharkhand, Ranchi
 Compensation
Meaning/Definition:
The term compensation is used to indicate the employee’s gross earnings in the form of
financial rewards and benefits.

Compensation can also be defined as follows:

 A system of rewards that can motivate the employees to perform.
 A tool that is used to foster values and culture.
 An instrument that enables an organization to achieve its objectives.

Compensation means the reward that is received by an employee for the work
performed in an organization.

It is an important function of human resource management. Employees may receive

financial and non-financial compensations for the work performed by them.
 Compensation
Meaning/Definition:
Financial compensation includes salary, bonus, and all the benefits and incentives,
whereas non-financial compensation includes awards, rewards, citation, praise,
recognition, which can motivate the employees towards highest productivity.

The management should ensure that compensation structure is designed after taking
into account certain factors such as qualification, experience, attitude and prevailing
rates in the markets.
 Compensation
Compensation System:
Compensation is a tool used by management for safeguarding the existence of the
company. Compensation can be of two types: direct and indirect.
Direct Compensation Indirect Compensation
• Basic pay • Provident fund
• Dearness Allowance • Gratuity
• Cash Allowance • Pension
• Incentive Pay • Insurance
• Bonus • Medical Leave
• Commission • Accident Benefits
• Profit Sharing • Maternity Leave
• Stock Option, and so on. • Sick Leave
• Casual Leave
• Travelling Allowance
• Telephone Bill, and so on.
 Compensation
Objectives:
1. The compensation should be paid to each employee on the basis of their abilities
and training.
2. Compensation should be in the form of package.
3. It should motivate the employees towards increasing productivity.
4. It should be capable of taking care of employees for safety and security needs also.
5. It should be flexible and clear.
6. It should not be excessive.
7. Compensation should be decided by the management as per the norms fixed by the
legislations in consultation with the union.
 Compensation
Principles (Compensation Management):
1. Ability to pay
2. Non-discriminatory
3. Legal compliance
4. Simple and flexible
5. Employee development
6. Performance orientation
7. Equity considerations
 Compensation
Components:
1. Basic wage/salary: Basic wage provides the foundation of pay packet. It is a price
for services rendered. Base wage is the cash compensation that an employer pays
for the work performed.

2. Dearness allowance: Dearness allowance also known as cost of living adjustments

was used for the first time after World War I to enable the workers to meet the steep
rise in prices of essential commodities such as food stuffs.

Also called as Cost of Living Allowance, the special allowance thus paid aimed at
neutralizing the increasing cost of living due to inflation and thus protect the real
wages of the wage earners.
 Compensation
Components:
3. Bonus: Bonus is defined as “an allowance in addition to what is usual, current or
stipulated; sum given or paid beyond what is legally required to be paid to the
recipient; something given in addition to what is ordinarily received by or strictly
due to the recipient”.

The word ‘bonus’ is also sometimes used to denote an incentive payment to the
workers aimed at enhancing their efficiency and loyalty to their organization.

4. Incentive compensation: The term incentive compensation refers to the portion of

an employee's salary that is related to performance, and not a guaranteed payment.

Incentive compensation is additional money, or other rewards of value such as

stock options, that are supplementary to base salary.
 Compensation
Components:
5. Fringe benefits: Fringe benefits include all expenditure by the employer on labour
other than basic wage and in a narrow sense it includes those benefits which the
employee can convert into cash.
Some examples of fringe benefits are:
• Medical and maternity benefits.
• Educational and recreational facilities.
• Payments for time not worked such as vacations, holidays, sick leave,
maternity leave, travel allowance, etc.
• Pension, provident fund, life insurance, gratuity.
• Housing benefits

Fringe benefits are also referred to as ‘Perquisites’ or ‘perks’. Perks include chauffeur
driven car, corporate aircraft, and company apartment, home security, club
membership, paternity leave, self defence training, company credit card, etc.
 Compensation
Designing and Administration of Wage and Salary Structure:
Developing/Designing a Wage and Salary Program/Structure:
The development of a compensation program involves four basic factors:
1. Establishing the wage level: In setting the compensation level, the manager
should consider the prevailing wage rate for local firms with similar jobs, the size
of the organization, and the firm’s financial position.

2. Setting the wage structure: The organization’s wage structure is the relative
compensation levels for various positions within the firm. The structure should
define both the base salary and the salary range for each position and the relative
salaries of each position in the firm.
 Compensation
Designing and Administration of Wage and Salary Structure:
Developing/Designing a Wage and Salary Program/Structure:
The development of a compensation program involves four basic factors:
3. Designing incentive systems: In order to be effective, any incentive system
requires that a good system of performance evaluation be in place.
Performance based incentives can increase productivity. However, basing too large
a portion of compensation on performance, particularly for lower wage level jobs,
can give some workers the feeling of too much uncertainty.

4. Setting individual wages within the wage and incentive structure: The
preceding steps have established the wage structure and incentive system and
determined compensation ranges for each position.
The final step is to set individual compensation. The performance evaluation
should be used to help set the compensation within the salary range.
 Compensation
Designing and Administration of Wage and Salary Structure:
Administration of Wage and Salary structure:
A sound wage policy is to adopt a job evaluation programme in order to establish fair
differentials in wages based upon differences in job contents.
Beside the basic factors provided by a job description and job evaluation, those that are
usually taken into consideration for wage and salary administration are:
• The organizations ability to pay
• Supply and demand of labour
• The prevailing market rate
• The cost of living
• Productivity
• Trade unions bargaining power
• Job requirements
• Psychological and sociological factors
• Levels of skills available in the market, and so on.
 International Compensation
Concept:
International compensation refers to all forms of monetary and non-monetary rewards
that employees of an international organization receive from their employer in
exchange for providing their labour and commitment for international assignments.

Designing and developing a better compensation package for HR professionals for the
international assignments requires knowledge of taxation, employment laws, and
foreign currency fluctuation by the HR professionals.

Moreover, the socio-economic conditions of the country have to be taken into

consideration while developing a compensation package.

It is easy to develop the compensation package for the parent country national but
difficult to manage the host and third country nationals.
 International Compensation
Objectives:
1. Attract and retain employees who are qualified and interested in international
assignments.
2. Facilitate the movement of expatriates from one subsidiary to another, from home
to subsidiaries, and from subsidiaries back home.
3. Provide a consistent and reasonable relationship between the pay levels of
employees at headquarters, domestic affiliates, and foreign subsidiaries.
4. Increase and maintain employee motivation.
5. Must be perceived as fair by the employees.
6. Secure consistency between pay and performance & equity among employees of
different nationalities and categories.
7. Assist the employee and family adapt to the host country culture.
8. Reduce employee grievances and simplify collective bargaining procedures.
9. To ensure that the package is both competitive and comparable.
 International Compensation
Components:
1. Base Salary: It denotes the main component of a package of allowances directly
related to the base salary and the basis for in-service benefits and pension
contributions. Base salary actually forms the foundation block of the international
compensation.

2. Benefits: The aspect of benefits is often very complicated to deal with. For
instance, pension plans normally differ from country to country due to difference in
national practices. Thus all these and other benefits (medical coverage, social
security) are difficult to imitate across countries.
Other kinds of benefits that are offered are:
• Vacation and special leaves
• Rest and rehabilitation leaves
• Emergency provisions like death or illness in the family
 International Compensation
Components:
3. Allowances: One of the most common kinds of allowance internationally is the
Cost of Living Allowance (COLA). It typically involves a payment to compensate
for the differences in the cost of living between the two countries resulting in an
eventual difference in the expenditure made.
Other major allowances that are often made are:
• Home leave allowance
• Education allowance
• Relocation allowance
• Spouse assistance (compensates for the loss of income due to spouse losing
their job)
 International Compensation
Components:
4. Incentives: In recent years some MNC have been designing special incentives
programmes for keeping expatriate motivated. In the process a growing number of
firms have dropped the ongoing premium for overseas assignment and replaced it
with on time lump-sum premium.

5. Tax Equalization/Protection: MNCs generally select one of the following

approaches to handle international taxation:
a. Tax equalization: Firm withhold an amount equal to the home country tax
obligation of the expatriate and pay all taxes in the host country.

b. Tax Protection: The employee pays up to the amount of taxes he or she would
pay on remuneration in the home country. In such a situation, the employee is
entitled to any windfall received if total taxes are less in the foreign country
than in the home country.
 International Compensation
Components:
6. Long Term Benefits: The most common long term benefits offered to employees
of MNCs are Employee Stock Option Schemes (ESOS).

7. Foreign Service Inducement and Hardship Premium: This is a component of

the total compensation package given to employees to encourage them to take up
foreign assignments.
This is done with the aim to compensate them for the possible hardships they may
face while being overseas.
 International Compensation
Factors affecting International Compensation:
Internal Environment:
 Competitive Strategy
 Organisational Culture
 Human Resource Structure
 Employee-Employer Relations
 Subsidiary Role
 Level of Technology
 International Compensation
Factors affecting International Compensation:
External Environment:
 Labour Market Characteristics
 Local Conditions
 Home & Host Country Government Rules
 Industry Type
 Competitor’s Strategies
 Incentives
Meaning/Definition:
Anything that can attract an employee’s attention and motivate them to work can be
called as incentive. An incentive aims at improving the overall performance of an
organization.
Incentives can be classified as direct and indirect compensation. They can be prepared
as individual plans, group plans and organizational plans.

According to Milton L. Rock, “incentives are variable rewards granted according to

variations in the achievement of specific results.”

According to K. N. Subramaniam, “incentive is system of payment emphasizing the

point of motivation, that is, the imparting of incentives to workers for higher
production and productivity.”
 Incentives
Incentives:
1. Financial Incentives: Some extra cash is offered for extra efficiency like profit
sharing plan and group incentive plans. e.g., bonus, retirement benefits, medical
reimbursement, etc.
Management needs to increase these financial incentives making wages and
salaries competitive between various organisations so as to attract and hold force.

2. Non-Financial Incentives: When rewards or prizes are provided by the

organization to motivate the employees it is known as non-financial incentives.
e.g.,
• Appreciation of Work Done
• Group Incentives
• Worker’s Participation in Management
• Opportunity for Growth
• Suggestion System
• Job Enrichment
 Incentives
Incentives:
3. Group Incentives: When two or more employees are involved in a particular
performance, incentives are provided to the group collectively, it is called a group
incentive. Group incentives make a strong sense where employee’s tasks are
interdependent and thus require a collective effort for the completion of such tasks.

4. Individual Incentives: Individual incentives refer to incentives given to individual

employees for their additional contribution towards organizational objectives.
Under it, incentives are calculated on the basis of individual performance that can
be measurable in quantitative terms.
It can be of following types:
• Piecework plan
• Commission
• Bonus, etc.