CHAPTER SEVEN

COMPENSATION AND
BENEFIT
ADMINISTRATION
 COMPENSATION
• Compensation is reward employees receive in exchange
for their performance. It is concerned with wages and
salaries, pay raises, and similar monetary exchange for
employees’ performance. Well-designed pay or
compensation system enables the organization:
- To attract qualified employees required
- To retain and motivate the existing workforce toward its
goal achievement.
• On the contrary, if compensation is not tied to work,
employees are likely to look for a better paying job.
Objectives of Compensation
• to establish fair and equitable rewards to the employees,
so that they are motivated to do the job in a better way for
the organization
• 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 organizations compete for employees.
• Retain current employees: Employees may quit when
compensation levels are not competitive, resulting in
higher turnover.
• Ensure equity: Compensation management strives for
internal and external equity. Internal equity requires that
pay be related to the relative worth of a job so those
similar jobs get similar pay. External equity means
paying employees what comparable employees are paid by
other organizations in the labor market.
• Reward desired behavior: Pay should reinforce desired
behaviors and act as an incentive for that behavior to occur
in the future.
• Effective compensation plans reward performance,
loyalty, experience, responsibility, and other related
behaviors.
• Control costs: A rational compensation system helps the
organization obtain and retain employees at a reasonable
cost. Without effective compensation management,
employees 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 the employer's compliance.
• Facilitate understanding: Human resource specialists,
operating managers and employees should easily
understand the compensation management system.
• Further administrative efficiency: Wage and salary
programs should be designed to be managed efficiently,
making optimal use of the organization’s human resource.
 Types of Compensation
• In general, there are two types of compensation. These
are:
1. Financial 2. Non-financial
Financial Compensation
• Financial compensation, as shown in the figure next page,
includes direct compensation, which is paid to employees
in the form of wages, salaries, bonuses, and commission
in exchange for their performance, and indirect
compensation includes all financial rewards that are not
included in direct compensation.
• It is important here to distinguish wage from other forms of
direct financial compensation.
• Wages are payments based on the number of units (hours, days)
that a person works for the organization or the number of units
produced (piece rate system). It is a payment to manual
workers.
• Salaries are money paid on monthly or annual basis to
employees whose output cannot be easily quantified. Clerical
and administrative staff receives salary.
• Bonuses, on the other hand, are lump-sum payments offered to
employees in recognition of successful performance, whereas
commission is a special form of incentive in which payments to
sales representatives are made on the basis of a percentage of the
sales value they generate.
• Non-financial Compensation includes any satisfaction,
which employees receive from the job, such as the need
for recognition, responsibility, personal growth and the
like or from environment in which they work. This job
environment consists of comfortable working conditions,
competent supervision, pleasant work companions and
other related physical and social needs of employees. For
example, being an accepted member of the work group
results in social motive satisfaction.
 Determinants of Financial Compensation

• Financial compensation system is influenced by a series of internal

and external factors, organization, the labor market, the job and the
employee have an impact on the job pricing and the ultimate
determination of employee’s financial compensation. The major
parties and issues of concern are shown in the figure below.
PARTIES MAIN ISSUES OF CONCERN
Government Ensure that financial compensation supports the social and economic
interests of the broader society.

Occupational Protect members’ human capital investment

groups
Unions Protect, maintain, and increase the welfare of the worker.
Individual Ensure that a balance is maintained between contributions to work and
the outcomes received from work.

Organization Within budget constraints, attract individuals into the organization,

retain employees, and motivate behavior toward achievement of
organizational goals.
 Organizational Interest in Compensation
Organizations view compensation mainly as a means:
• To attract qualified candidates for vacant positions
• To retain competent and dedicated employees
• To facilitate performance
• To comply with government employment policies.
• Moreover, compensation is an expense in the sense that it
reflects the cost of labor. Organization often has
compensation policies. As organizations differ in size and
purpose, so do in pay levels, there are three alternative
strategies, this might be chosen by organizations. These
are high, low, and comparable.
• The high-pay-level strategy: In this strategy, the
organization chooses to pay higher than the average pay
levels. The assumption is that paying a higher salary or
wage will enable organizations attract and retain competent
employees and this, in turn enhance employees' productivity.
• The low-pay-level strategy: In this alternative, the
organizations pay a minimum salary or wage to employees.
This may be because of poor financial condition or the work
does not require highly qualified personnel. The low
compensation policy does not save money; rather it is quite
expensive. In addition to being unproductive, low paid
workers usually damage their work instruments because of
insufficient knowledge and skill.
On the other hand, organizations using low pay strategy
may also have a high labor turnover rate.
• The comparable-pay-level strategy: This strategy
requires organizations to follow “equal pay for equal
work”. Here employees are paid based on comparable
value of jobs they are performing.
• The choice of any of the above pay-level strategies may
be affected by factor internal or external to the
organization. The following are some of the major
factors that affect compensation decision.
- Quality and quantity of needed skill
- The organization’s current financial position and
financial prospects for the coming year.
- Cost of living index
- Employees’ behavior, such as performance, turnover,
absenteeism, unionization attempts, and sabotage
• Furthermore, the profit levels of an organization can also
affect employees’ salaries or wages. This being the case,
who is a pay policy-decision maker? In most
organizations, the top-level management makes pay
decisions by considering the above factors.
 Labor Markets Influence on Compensation
• The number and types of employees indicated in the
organization’s human resource planning are mainly drawn
from the labor market. Since the market directly affects the
pay-levels, analysis of the demand for and supply of labor is
imperative. The demand for human resources largely depends
on organization's ability to pay. On the other hand, the supply
focuses on the number of persons of work age; the
attractiveness of the job in pay, benefits, and psychological
rewards; the availability of training institutions, and so on.
When the supply of employees exceed the demand, the initial
pay-levels tend to go down. On the contrary, when the
demands for employees exceed the supply, the initial pay-
levels tend to go up.
 Job Influence on Compensation
• Organizations appear to attribute similar values for similar
jobs and different values to different jobs. In other words,
jobs employees are assigned to perform are a major
decisive factor of the amount of pay they will in turn
receive. Organizations pay for the value they attach to
certain duties, responsibilities, and other job-related
factors. If this is the case, the question of what are the
techniques used to determine the value of jobs is an
important one that requires an answer.
• Compensation techniques used by organizations for
determining the relative value of jobs are job analysis and
job evaluation.
 Job Analysis

• If compensation policy is to be based on the nature of

job, a job analysis activity must be conducted to identify
the similarities and differences among the various jobs in
the organization. It is based on job analysis that
organizations assign a financial value to each job. Thus,
unless there is a clear definition of the job and job
performance standards it would be difficult to imagine
how pay can be linked to individual performance. It is
worth noting that job evaluation is also a means to
compare the relative values of various jobs in an
organization.
 Job Evaluation
• Job evaluation is that part of a compensation system in
which a firm determines the relative value of one job in
relation to another. The major reason of job evaluation is
to maintain internal pay equity among various jobs in the
organization. Moreover, job evaluation is used to:
- Identify the organization’s job structure
- Bring equity and order to the relationships among jobs
- Develop a hierarchy of job value that can be used to
create a pay structure
- Achieve a consensus among managers and employees
regarding jobs and pay with in the firm
• Job evaluation rates the job and not the employee
performing the job. It is, therefore, a process of analyzing
the worth of a job to that of another, without regard to
personalities on the jobs. In this process accurate job
descriptions and job specifications must be available to
analyze and assign monetary value to organizational jobs.
• Organizations use four major types of job evaluation
methods. There are:
1. Job Ranking, 2. Job Grading, 3. Factor Comparison and
4. Point System
 1. Job Ranking Method

• The simplest method of job evaluation is ranking. A

committee or evaluators review the job descriptions and
rank each job from the simplest to most challenging job in
the organization. This job-ranking method is based on
subjective evaluation of relative value. Compensation for
each job will be based on the job hierarchy. The ranking
method is more suitable for small organizations having a
limited number of employees.
 2. Job Grading Method
• The job grading or the classification method works by having each
job assigned to a grade by matching standard descriptions with
each job’s description, as shown below.
• Here jobs are assigned to grades by comparing the job description
with the standard description. The sample below indicates five
grades. Jobs, which might be classified under grade I, are simple
and routine. Jobs become more difficult as the grade level
increases. For example, jobs under grade IV are believed to be
complex and require high-level skill. In attaching monetary values
to the various jobs, the rater makes pay-level differentials between
jobs, based on their complexity. More challenging jobs in an
organization are paid more. In this non-analytical method
“complex jobs are difficult to fit into the system; a job may seem to
have the characteristics of two or more grades.
JOB STANDARD DESCRIPTION
GRADE
I Work is simple and highly repetitive, done under close supervision, requiring minimal
training and little responsibility or initiative.
Examples: Janitor, file clerk
II Work is simple and repetitive, done under close supervision, requiring some training
or skill. Employee is expected to assume responsibility or exhibit initiative only
rarely.
Examples: Clerk-typist I, machine cleaner
III Work is simple, with little variation, done under general supervision. Training or skill
required. Employee has minimum responsibilities and must take some initiative to
perform satisfactorily.
Examples: machine oiler, clerk typist II
IV Work is moderately complex, with some variation, done under general supervision.
High level of skill required. Employee is responsible for equipment or safety;
regularly exhibits initiative.
Examples: Machine operator I
V Work is complex, varied, done under general supervision. Advanced skill level
required. Employee is responsible for equipment and safety; shows high degree of
initiative.
Examples: Machine operator II, tool specialist.
3. Factor Comparison Method
• This method demands a more quantitative analyses of the
jobs involved. In this method, each job is broken down
into factors, which are considered common to all types of
jobs. The compensable factors used to compare jobs in
the organization are skill, mental requirements, physical
requirements, responsibilities and working conditions.
For each job in the organization, the factors are “ranked
according to their relative importance in each job and then
the job evaluator assigns a monetary value to each factor.
For example, a job with worth of Birr 1, 200 per month
may have its different contributing factors costed as
follows:
Compensable Factors Allotted Birr

Skill Requirements 240

Mental Requirements 360
Responsibility 240
Physical Requirements 192
Working Conditions 168

Total Job Value Birr1,200

 4. Point Method
• The point rating system is the most accurate and widely
used method of job evaluation. This system resembles the
factor comparison method in that, in both cases, jobs are
broken down into factors like skill, mental effort,
responsibility, physical effort and working conditions.
However, unlike the factor comparison where monetary
value is assigned to each job, here points are used to
determine the worth of jobs in the organization.
• In allocating range of points to each job factor, the
following steps may be followed.
1. Assign a number (between 1 and 100) to each factor.
2. Closely examine each factor in terms of its importance in
relation to the other. For example, as shown in the figure
below, the physical effort requirements for the job of labor
is thrice as important as skill requirements.
3. Finally, each factor point value is added, to place job in
order of importance.
Factor
Job Title Skill Mental effort Responsibility Physical effort Working conditions Total
Inspector 20 20 40 5 5 90
Secretary 20 20 35 5 5 85
File clerk 10 5 5 5 5 30
Laborer 5 2 2 17 9 35

As can be seen from the above table, it would mean that the inspector’s
salary rate is thrice that of the file clerk. In this manner, point-rating
system would result into a logical monetary job-worth for all jobs in
organizations.
 Employee Influences on Compensation

• The major goals of compensation are to attract and retain

qualified employees to the organization.
• Compensation affects employee decision to stay or leave
the organization, to work effectively and to accept
additional responsibilities. An effective compensation
system is designed to satisfy employee needs and
reinforce job behavior consistent with organizational
objective.
• Recall from the earlier discussion that organization, labor
market, and the job influence compensation system.
Moreover, factors related to employee like performance, seniority,
and experience also determine pay levels in an organization.
 Compensation and Performance
• Paying for performance is the process of providing a financial reward
to an individual, which is linked directly to his/ her performance.
Nothing is more demotivating to productive employees than to be paid
equal salary as less productive employees. If this is the case,
organizations need to practice varies method to improve job
performance.
• The most common once are piecework, bonus schemes and
commission. Piecework (Payment-by-Results) is a reward system in
which rewards are related to the pace of work / effort. That is, the
faster an employee works, the higher the output and the greater the
reward. Bonuses are rewards for successful performance and are paid
to employees as lump sum. Commission, on the other hand, is a
reward paid on the performance of individual, typically salaried/sales.
The commission earned is a proportion of the total sales and may be
added to basic salary.
 Seniority and Experience

• Seniority refers to the length of time employees have been

working in an organization. Employees are more likely to be
committed to the achievement of organizational objectives, if
their long services are considered as a basis for pay increases
or have some value during promotion.
• Advocates of paying for seniority believe that it enables the
organization to maintain stable workforce without excessive
turnover. The seniority must be linked with experience on the
job.
• Organizations compensate employees on the basis of experience,
because “sometimes the practice is justified because of the valuable
insights that can only be acquired through experience on the job".
 Pay Structures
• In the process of considering the values of jobs in an
organization, attention must paid to the job evaluation
results and the pays in the labor market.
• The relative value of jobs, in the organization, is
determined by the job evaluation whereas its absolute
value is determined by the labor market (supply and
demand).
• To set the pay level the job evaluation and pay survey rates
are combined using graph. As shown in the graph next
page, the horizontal axis shows job structure originated
through job evaluation. All similar jobs are classified in
one grade and they have the same range.
A pay grade is the grouping of similar jobs to simplify the job pricing process.
For example, as can be noted from the graph, key jobs ABC (grade 1) have
lower pays and pay range than jobs DEF (grade 2). The pay range defines the
lower and upper limits of pay for jobs in a grade. The range allows
organizations to pay according to seniority and or performance. The vertical
axis in the graph represents the pay rates. The midpoint can be established by
the use of pay-survey data from similar jobs. In the graph, on the vertical axis
the pay level policy line has been set to equal the average paid by the
organization’s competitors for each of the jobs: a matching-competition policy.
 Benefits (Indirect Compensation )
• In addition to financial compensation, employees aspire various
benefits because of their membership in the organization.
• What then are benefits? Employee benefits are the indirect form of
the total compensation; they include paid time away from work,
insurance and health protection, employee services, and retirement
income.
• Recall that direct compensation such as salaries, wages or bonuses
are based on the nature of the jobs and employees performance.
• Benefits, however, are indirect compensation that organizations
provide to their employees and are not directly related to
performance.
Objectives
• What do organizations gain from benefits?
• Benefits enable organizations to retain and attract
qualified personnel. Moreover, employee benefits
policies of an organization are to: Reduce fatigue,
Discourage labor unrest, Satisfy employee
objectives, Aid recruitment, Reduce turnover,
Minimize overtime costs.
 Major Categories of Benefits

1. Insurance Benefits: The financial risks encountered by

employees and their families can be spread by insurance.
These risks are shared when funds are pooled in the form of
premiums. Then, when insured risks occur, the covered
employees or their families are compensated. Here
organizations can purchase life, health and work related
accident insurance.
2. Security Benefits: These are non-insurance benefits that
provide income protection to employees before and after
retirement. Provision of such benefits is based on earnings
and years of services in the organization. The benefits are
effective during separation, retirement, death, and disability.
3. Time-off Benefits: In this type of benefit employees are
paid for time not involved in performance. Time-off
benefits include sick leave, holidays, vocations,
maternity leave, education leave and other related leave
of absence. Here employees are provided with an
opportunity to rest and refresh their minds.
4. Employee Services: These services include educational
assistance, subsidized food services, financial and social
services and the like.
 Non-financial Compensation
• So far, we have discussed employee benefits, which cost
the organization money either directly or indirectly.
Advocates of motivation claim that employees are not
only be satisfied with basic needs, but other subsequent
needs such as social, ego, and self-actualization are
becoming more important. These higher order needs may
be satisfied through the job or job environment or both.
The benefits each employee would value depend on their
personal preferences. In most cases, employees may get
personal satisfaction if the job provides them opportunities
for recognition, feeling of achievement, and above all
advancement opportunities.
• Jobs to be challenging, meaningful, and interesting, organizations
must attempt to match the job requirements and individual
abilities.
• The selection and placement processes are extremely important
in this context. In addition, organizations must establish the
proper working environment so that employees perform their jobs
effectively. By creating a conducive job environment, supervisors
should enable their subordinates to do their jobs to the best of
their abilities.
• Other major factors that are part of job environment include
sound policies, congenial co-workers, appropriate status
symbols and comfortable working conditions. These factors,
among other things are hoped to lead to job satisfaction, improve
morale and increase employee commitment.
The End …