INTRODUCTION
TO COMPENSATION
MANAGEMENT
Dejene Adugna (PhD)
CHAPTER 1

Introduction
 Compensationrefers to all forms of pay going to employees and arising
from their employment.
 Is what employees receive in exchange for their contributionto the
organization
 Compensationis a reward Employees receive in exchange for their
performance.

Definition Compensation…
 Is total Monetary and nonmonetary rewards provided by companies
to attract, motivate, and retain employees.
 The term ‘compensation’ refers to all forms of financial returns and
tangible benefits that employees receive as part of the employment
relationship
 Refers to as a wide range of financial and non-financial rewards
given to employees for their services rendered to the organization

Compensation management
 It is about the design, implementation and maintenance of reward
systems which aim to meet the needs of both the organization and its
stakeholders.
 The overall objective is to reward people fairly, equitably and
consistently in accordance with their value to the organization in
order to further the achievement of the organization’s strategic
goals.

Classification of
compensation
1. Financial Compensation
a. Direct financial compensation
b. Indirect financial compensation
2. Non-Financial Compensation

Financial compensation
 Financial compensation is most popular and important compensation
that is given in the form of money.
 Direct compensation means compensating employees by paying them
money in the following forms
o Basic pay
o Incentives
o Bonus
o Allowances
o Commission

A)basic pay/salaries and wages
 It is normally a fixed amount which is subject to changes based on
annual increments or subject to periodical pay hikes
 Salaries: monthly rate of pay/ irrespective of the number of hours
put in by the employee
 A fixed amount which is subject to changes based on annual
increments or subject to periodical pay rises.
 Wages represent hourly rates of pay
 Both differ from employee to employee, and depend upon the
nature of job, seniority, and merit

B) Dearness Allowance
 The payment of dearness allowance facilitates employees and
workers to face the price increase or inflation of prices of goods
and services consumed by him.
 The onslaught of price increase has a major bearing on the living
conditions of the labor.

C)Incentives
 Incentives are paid in addition to wages and salaries and are also
called ‘payments by results’.
 Incentives depend upon productivity, sales, profit, or cost
reduction efforts.
There are:
 Individual incentive schemes, and
 Group incentive schemes

Incentives…
 Individual incentives are applicable to specific employee
performance.
 Group incentive are paid to the group when the given task
demands group efforts for completion

D) 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 when sales revenue or profit margin
achieved
 The Government also prescribes a minimum statutory bonus for all
employees and workers.

Commissions
 It is always a fixed percentage on the target achieved. For
taxation purposes, commission is again a taxable component of
compensation.
 Depending upon the targets achieved, companies may pay a
commission on a monthly or periodical basis

Indirect Compensation (Fringe Benefits)
 Refers to payments employees receive for continuing their
employment with the company which are an important part of every
employee’s compensation.
 Are elements of remuneration given in addition to the various forms
of cash pay.
 It involves rewards provided by organizations to employees for
their membership, attendance or participation in the organization.

Types of Indirect Compensation
 Social Security
 Workers’ Compensation
 Retirement Plans
 Paid Holidays
 Paid Vacations
 Other Benefits

Social Security
 This is a federally administered insurance system.
 According to law, both employer and employee must pay into the
system, and a certain percentage of the employee’s salary is paid
up to a maximum limit.
 How much is paid by employer and employee is calculated on the
average monthly wage (weighted towards the later years). It is
provided mainly to give financial security to employees when they
retire.

Workers’ Compensation
 It is meant to protect employees from loss of income and to cover
extra expenses associated with job-related injuries or illness.
 The laws generally provide for replacement of lost income,
medical expenses, rehabilitation of some sort of death benefits to
survivors, and lump-sum disability payments.

Retirement Plans
 Retirement and pension plans, which provide a source of income
to people who have retired, represent money paid for past
services.
 One popular form of pension plan is the defined-benefit plan.
Under this plan, the employer pledges to provide a benefit
determined by a definite formula at the employee’s retirement
date.
 The other major type of retirement plan is the defined contribution
plan, which calls for a fixed or known annual contribution instead
of a known benefit.

Paid Holidays
 These comprise Christmas Day, New Year’s Day, Labour Day, etc.
 One relatively new concept is the floating holiday, which is observed
at the discretion of the employee or the employer.
 Another relatively new concept is referred to as personal time-off or
personal days. Under this concept, organizations give employees a
certain number of days with pay to attend to personal affairs.
 Normally these days can be taken at the employee’s discretion.

Paid Vacations
 Typically, an employee must meet a certain length-of-service
requirement before becoming eligible for paid vacation. The time
allowed for paid vacations generally depends on the employee’s
length of service.
 Unlike holiday policies that usually affect everyone in the same
manner, vacation policies may differ among categories of
employees.
 Most organizations allow employees to take vacation by the day or
week but not in units of less than a day.

Other Benefits
 Organizations may offer a wide range of additional benefits,
including
 Food services
 Exercise facilities
 Health and first-aid services
 Financial and legal advice, and
 Purchase discounts.
 The extent and attractiveness of these benefits vary considerably
among organizations. For example, purchase discounts would be
especially attractive to employees of retail store or an airline.

Non-Financial Compensation
 Non-financial compensation refers to compensating employee not in
form of money but in some other forms that stimulate employees’
morale and also improve his performance.
It can be in the following forms
 Job security
 Recognition
 Participation
 Pride in job
 Delegation of responsibility
 Other incentives

Principles of compensation
 To be legal: It must get approval from the govt. or top
management in the organization
 To be adequate: compensation must be sufficient so that needs of
the employees are fulfilled substantially
 To be Motivational: compensation must increase the level of
motivation and job satisfaction of the employees.
 To be equitable: compensation policy should be declared in such a way
so that no discrimination can be observed.

Principles of compensation
 To provide security: Employees must have
guarantee of getting wages or compensation
regularly without any break.
 To be cost benefit effective: The organization must make a
balance between cost for giving compensation and
benefits to be accrued from the employees.

Objectives of compensation management
 Acquire qualified personnel
 Retain current employees
 Ensure equity
 Reward desired behaviour
 Control costs
 Facilitate understanding

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 labour market since employers compete for workers.
 Premium wages are sometimes needed to attract applicants
already working for others.

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 that similar jobs get similar pay.
 External equity means paying workers what comparable workers are
paid by other firms in the labour market.

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

Control costs
 A rational compensation system helps the organization
obtain and retain workers at a reasonable cost.
 Without effective compensation management, workers
could be overpaid or underpaid.
 Comply with legal regulations.

Facilitate understanding
 The compensation management system should be easily
understood by human resource specialists, operating
managers, and employees.

Factors considered in deciding the compensation

Demand and Supply of Labor
 The primary result of the operation of the law of supply and
demand is the creation of the going wage rate.
 It is not practicable to draw demand and supply curves for each
job in an organization even though, theoretically, a separate curve
exists for each job.

Cost of Living
 Varying wage depending upon the variations in the
cost of living index following rise or fall in the
general price level and consumer price index.

Labor Union
 Organized labor is able to ensure better wages than the unorganized
one.
 Higher wages may have to be paid by the firm to its workers under the
pressure or trade union.
 If the trade union fails in their attempt to raise the wage and other
allowances through collective bargaining, they resort to strike and
other methods hereby the supply of labor is restricted.

Government
 To protect the employees from the exploitations of powerful
employers, government can enact Laws on minimum wages,
hours of work, equal pay for equal work, payment of dearness
and other allowances, payment of bonus, etc.
 Wages and salaries can’t be fixed below the level prescribed by
the government

Prevailing Wage Rates
 Influence by the general wage level or the wages paid for
similar occupations in the industry, region and the economy as a
whole.
 External alignment of wages is essential because if wages paid
by a firm are lower than those paid by other firms, the firm will
not be able to attract and retain efficient employees.

Internal Factors
Ability to Pay
 It depends upon the financial position and profitability of the firm.
 If the firm is highly successful, there is little need to pay more than
the competitive rates to obtain employees
 Ability to pay is an important factor affecting wages, not only for
the individual firm but also for the entire industry.

Top ManagementPhilosophy
 As wage and salary payments constitute a major portion of
costs and /or apportionment of profits to the employees, top
management may like to keep it to the minimum.
 On the other hand, top management may like to pay higher
pay to attract top talent.

Productivity of Workers
 Productivity is the key factor in the operation of a company.
 High wages and low costs are possible only when productivity
increases appreciably.

Job Requirements
 Measures of job difficulty provide a basis for determining the relative
value of one job against another in an enterprise.
 The occupational wage differentials in terms of
 Hardship
 Difficulty of learning the job
 Stability of employment
 Responsibility of learning the job and
 Change for success or failure in the work.

Employees Related Factors
These include
 Performance
 Seniority
 Experience
 Potential

Organizational Politics
 Determination of firms : managers could make their firm appear to
be a wage leader by including in the survey those organizations that
are pay followers.
 Choice of compensable factors for the job evaluation plan:
 Emphasis placed on either internal or external equity
 Results of employee performance appraisal may be intentionally
disported by the supervisor

Theories of Compensation Management
 Reinforcement Theory
 Equity Theory
 Agency Theory

Reinforcement theory
 If a person is rewarded for a particular behavior, he/she is
more likely to perform those actions again

Equity theory
 suggests that employees' actions will be changed based on
their perception of how they are paid in comparison to their
coworkers.

Agency theory
 Pay in order to get the different interests of people
involved with the company
 Focuses on the diverse interests and goals of the
stakeholders in an organization