COMPENSATION MANAGEMENT

MODULE-1 Conceptual frame work of compensation management Theories of wages subsistence theory wage fund theory marginal productivity theory bargaining theory Criteria of wage fixation

Conceptual Frame Work of Compensation Management: Human Resource is the most vital resource for any organization. It is responsible for each and every decision taken, each and every work done and each and every result. Employees should be managed properly and motivated by providing best remuneration and compensation as per the industry standards. The lucrative compensation will also serve the need for attracting and retaining the best employees. Compensation is the remuneration received by an employee in return for his/her contribution to the organization. It is an organized practice that involves balancing the work-employee relation by providing monetary and non-monetary benefits to employees. Compensation is an integral part of human resource management which helps in motivating the employees and improving organizational effectiveness. Components of Compensation System Compensation systems are designed keeping in minds the strategic goals and business objectives. Compensation system is designed on the basis of certain factors after analyzing the job work and responsibilities. Components of a compensation system are as follows:

Types of Compensation Compensation provided to employees can direct in the form of monetary benefits and/or indirect in the form of non-monetary benefits known as perks, time off, etc. Compensation does not include only salary but it is the sum total of all rewards and allowances provided to the employees in return for their services. If the compensation offered is effectively managed, it contributes to high organizational productivity. Direct Compensation Direct compensation refers to monetary benefits offered and provided to employees in return of the services they provide to the organization. The monetary benefits include basic salary, house rent allowance, conveyance, leave travel allowance, medical reimbursements, special allowances, bonus, Pf/Gratuity, etc. They are given at a regular interval at a definite time. Basic Salary Salary is the amount received by the employee in lieu of the work done by him/her for a certain period say a day, a week, a month, etc. It is the money an employee receives from his/her employer by rendering his/her services. House Rent Allowance Organizations either provide accommodations to its employees who are from different state or country or they provide house rent allowances to its employees. This is done to provide them social security and motivate them to work.

Conveyance Organizations provide for cab facilities to their employees. Few organizations also provide vehicles and petrol allowances to their employees to motivate them. Leave Travel Allowance These allowances are provided to retain the best talent in the organization. The employees are given allowances to visit any place they wish with their families. The allowances are scaled as per the position of employee in the organization. Medical Reimbursement Organizations also look after the health conditions of their employees. The employees are provided with medi-claims for them and their family members. These medi-claims include health-insurances and treatment bills reimbursements. Bonus Bonus is paid to the employees during festive seasons to motivate them and provide them the social security. The bonus amount usually amounts to one months salary of the employee. Special Allowance Special allowance such as overtime, mobile allowances, meals, commissions, travel expenses, reduced interest loans; insurance, club memberships, etc are provided to employees to provide them social security and motivate them which improve the organizational productivity. INDIRECT COMPENSATION Indirect compensation refers to non-monetary benefits offered and provided to employees in lieu of the services provided by them to the organization. They include Leave Policy, Overtime Policy, Car policy, Hospitalization, Insurance, Leave travel Assistance Limits, Retirement Benefits, Holiday Homes. Leave Policy It is the right of employee to get adequate number of leave while working with the organization. The organizations provide for paid leaves such as, casual leaves, medical leaves (sick leave), and maternity leaves, statutory pay, etc.

Overtime Policy Employees should be provided with the adequate allowances and facilities during their overtime, if they happened to do so, such as transport facilities, overtime pay, etc. Hospitalization The employees should be provided allowances to get their regular checkups, say at an interval of one year. Even their dependents should be eligible for the medi-claims that provide them emotional and social security. Insurance Organizations also provide for accidental insurance and life insurance for employees. This gives them the emotional security and they feel themselves valued in the organization. Leave Travel The employees are provided with leaves and travel allowances to go for holiday with their families. Some organizations arrange for a tour for the employees of the organization. This is usually done to make the employees stress free. Retirement Benefits Organizations provide for pension plans and other benefits for their employees which benefits them after they retire from the organization at the prescribed age. Holiday Homes Organizations provide for holiday homes and guest house for their employees at different locations. These holiday homes are usually located in hill station and other most wanted holiday spots. The organizations make sure that the employees do not face any kind of difficulties during their stay in the guest house. Need of Compensation Management A good compensation package is important to motivate the employees to increase the organizational productivity. Unless compensation is provided no one will come and work for the organization. Thus, compensation helps in running an organization effectively and accomplishing its goals.

 Salary is just a part of the compensation system, the employees have other psychological and self-actualization needs to fulfill. Thus, compensation serves the purpose. The most competitive compensation will help the organization to attract and sustain the best talent. The compensation package should be as per industry standards. Theories of Wages: Wage concept: Money paid to the worker is considered as his wage. This money includes basic salary, benefits, pension, welfare fund, social security, vacations and holidays are regarded as fringe benefit. These are the pay in addition to wages and form part of total labour costs. In the word of British Ministry of Labour and National Services. (BMLNS) wage is the payment made to the workers for placing their skill and energy at the disposal of an employer, the method of use of that skill and energy being at the employers discretion and amount to the payment being in accordance with terms stipulated in a contract of service Various terms we can use in the payment system are wage, pay, compensation and earning. The two terms often used interchangeably are wages and salary. if a worker is paid by the year, he is considered to be in receipt of a salary, not wages. If he is paid by hour or day, he is stated to be in receipt of wages. Salary is made for white collar employees and wage is denoting for bluecollar worker. A global View In English compensation means something that counterbalances. In China the traditional characters for the word compensation are based on the symbols for logs and water. Compensation provides necessecities of life. In Japan compensation means housyu, which means reward. Forms of Pay: The variety of returns people receive from work. They are categorized as total returns and relational returns. Total compensation returns are more

transactional.. It include pay received directly as cash. I.e. base, merit, incentives, cost-of living adjustment). It also include indirectly as benefits (pension ,medical insurance, program to help balance to help balance work and life demands. Cash Compensation: Base Base wage is the cash compensation that an employer pays for the work performed. Base wage tends to reflect the value of the worker skills and generally ignores differences attributable to individual employees. EX-base wage of machine operators may be $20 an hour. The cash compensation is different for different base of employees. Cash compensation: Merit pay / cost of living adjustment Periodic adjustment to base wages may be made on the basis of changes in what other employers are paying for the same work, changes in the overall cost of living, or change in experience or skill. Merit increase are given as increments to the pay in recognition of past work behavior. Ex- 90% of US firms are merit based pay increase. Cash Compensation: Incentives Incentives tie pay increase directly to performance. It is different from merit base pay. Bcoz it does not increase the base wage, and so must be re-earned each pay period. Secondly potential size of the incentive payment will generally be known beforehand. Incentive may be long term and short term. Long term incentives are intended to focus employee efforts on multi year results. Typically they are in the form of stock ownership or option to buy stock at specified advantageous price. Benefits: Income Protection In United states the employer must pay into a fund that provides income replacement for workers who become disabled or unemployed. In some country employers also make half the contributions to social security. (employees pay the other hand). Ex- medical insurance, retirement programs, life insurance, and savings plans are common benefit. These are help to protect employees from the financial risks inherent in daily life. Often companies can provide these protections to employees cheaper

than employees can obtain them for themselves. Because the cost of providing benefit is rising. Benefits: Work/ Life Balance The programme that help employees better integrate their work and life responsibilities include time away from work(vacation, jury duty)., access to services to meet specific needs and flexible working arrangements. Benefits: Allowances Allowances are may be house rent allowances, transport allowances. Almost all foreign companies in china discover that housing, transportation, and other allowances are expected. Relational- Returns from work: There is no doubt that non-financial returns from work have substantial effect on employees behavior, which includes relational returns from work as recognition and status, employment security, challenging work and opportunity to learn. Other relational forms might include personal satisfaction from successfully facing new challenges, teaming with great coworker, receiving new uniforms. Subsistence Theory: This theory originated with the Physiocratic school of the French economists and was developed by Adam Smith and the classical school of thoughts. It is also known as the iron law of wages or brazen law of wages. Karl Marx made it the basis of this theory of exploitation. The Subsistence Theory of Wages, also known as the "Iron Law of Wages," was an alleged law of economics that asserted that real wages in the long run would tend to the value needed to keep the workers' population constant. The alleged law was named and popularized by the German socialist Ferdinand Lassalle in the mid 1800s According to the subsistence theory wages tend to settle at the level just sufficient to maintain the worker and his family at the minimum subsistence level. The workers are encouraged to marry and to have large families due to increase in wages above the subsistence level. In this way, the supply of labor increase and it will bring wages down to the subsistence level.

 The marriages and births are discouraged due to fall in wages below this level. It will also cause to increase the death rate. The supply of labor decreases and it will cause to rise in wages to the subsistence level. The theory also pronounced with the theory of productivity of Labour or theory of value and regarded Labour as the source of the fund which originally supplied every nation with all the necessaries and conveniences of life which it annually consumed. Division of Labour became for Adam Smith the principal cause of increasing productivity. Subsistence theory of wages states that in the long run, wages would tend towards that sum which is necessary to maintain a worker and his family. Wage beyond the subsistence level would induces workers to have larger families resulting in spurt in supply of Labour which brings down wages to subsistence level. Criticism: 1. Wages are not cause of increase in population: When the wage of a worker increases, his living standard also increases. The worker does not want to produce more children. In actual life, the birth rate is higher in poor countries. 2. Wage Differences: This theory does not explain the wage differences among the workers due to education, skills, training etc. this theory explains only the wage rates that tends to be equal to subsistence level of all the workers. 3. Trade union: The trade unions have there important role for determination of wages. This theory ignores the role of trade unions. Wage fund theory: The credit for formulating another theory of wages, complementary to, rather than a substitute for, the subsistence theory, goes to John Stuart Mill. The theory known as the wages-fund or wage-fund theory was first suggested by Adam Smith when he intimated that a store of funds was available out of which wages could be paid.

 J. R. McCulloch, James Mill, Nassau Senior, Malthus, and Ricardo all found the concept of a wages-fund acceptable as an explanation for the level of wages. Wages; according to this theory described by John Stuart Mill, depended upon the relationship which existed between the supply of population and the capital available to employ workers. Mill was forced to add qualifications to the concepts of population and capital. By the former he meant those members of the laboring population who offered their services for hire; and by the latter, the amount of capital to be used for the payment of wages and any amounts incidental to the hire of laborers. Thus the funds available for wages were fixed at any given time, and the only way to increase wages was to reduce the number of wages to be paid or increase the capital funds available. The theory had important bearing upon the relation of trade unions and legislation to wages. At best the effect of either of these would be merely the shifting of a share of wages from one group of wage earners to another, since no absolute increase in the total wages paid was possible. That there was no fundamental contradiction between the subsistence and the wages-fund theories is clearly demonstrated by the fact that the strongest advocates of the subsistence theory also accepted the wages-fund theory without criticism. Criticism Criticism of the wages-fund theory came from a variety of sources. Several decades before the final statement of the wages-fund theory, F. B. von Hermann in Germany had raised objections to it. Later Francis Walker, Francis Longe, and W. T. Thornton pointed out such errors and impracticalities that the theory failed to survive. These writers pointed out that it was the consumers who set the demand for labor, and workers might be provided for out of current income as well as from capital.

 Also there was no specific fund for wages which was separable from other funds to be used in production. The "fund" then was really a matter of the employer's discretion as to how much he would provide for wages. Marginal Productivity Theory: A theory used to analyze the profit-maximizing quantity of inputs (that is, the services of factor of productions) purchased by a firm in the production of output. Marginal productivity theory indicates that the demand for a factor of production is based on the marginal product of the factor. In particular, a firm is generally willing to pay a higher price for an input that is more productive and contributes more to output. The demand for an input is thus best termed a derived demand. Marginal productivity theory is a cornerstone in the analysis of factor markets and the input side of short-run production. It provides insight into the demand for factors of production based on the notion that a profitmaximizing firm hires inputs based on a comparison between the productivity of the input and the cost of the input. The Law of Diminishing Marginal Returns, the central principle underlying marginal-productivity theory is the law of diminishing marginal returns. This law states that as additional units of a variable input are added to a fixed input, eventually the marginal product of the variable input decreases. This principle is an essential component of short-run production analysis, which offers insight into the positively-sloped marginal cost curve and the law of supply. The law of diminishing marginal returns also plays a key role in the demand for an input. It works like this: As more of an input is employed, marginal productivity declines. Because each unit is less productive and generates less revenue, the firm is inclined to pay less to use the input. As such, an inverse relation exists between the price of the input and the quantity of the input demanded, which traces out a negatively-sloped factor demand curve. Three (or Four) Marginals The focus of marginal productivity theory and the law of diminishing marginal returns is on marginal product. There are, however, three related "marginals" that need to be noted:

 Marginal Product: This is the change in total product resulting from an incremental change in the quantity of the variable factor input used. Marginal Physical Product: This is another term for marginal product which serves to emphasize that production is measured in physical units rather than monetary units. Marginal Revenue: This is the change in total revenue resulting from an incremental change in the quantity of the output produced. Marginal Revenue Product: This is the change in total revenue resulting from an incremental change in the quantity of the variable factor input used. Marginal revenue product is marginal product stated in monetary units rather than physical units. Rather than stating productivity of an input in terms of the physical quantity of production, marginal revenue product states productivity in terms of the revenue generated. Suppose, for example, that Edgar Millbottom contributes 5 tacos per hour of production when hired by Waldo's TexMex Taco World. Edgar's marginal (physical) product is thus 5 tacos per hour. However, because each taco sells for $2 each (marginal revenue), Edgar contributes $10 per hour of revenue to Waldo's TexMex Taco World. Waldo, the owner of Taco World, is more interested in the amount of revenue Edgar generates when it comes to making out a paycheck, than just the number of tacos produced. This connection between marginal product, marginal revenue, and marginal revenue product is summarized in by the following equation: marginal revenue product=marginal product x marginal revenue A Derived Demand Marginal productivity theory reveals that the demand for a factor input is not based so much on the factor itself, but on the contribution the input makes to the firm's revenue and profit. The demand for an input is thus a derived demand. In particular, an input is highly valued if it produces an output that is highly valued. Alternatively, an input is not highly valued if it produces an output that is not highly valued. For example, Harold "Hair Doo" Dueterman thrills millions of fans from April to September as a superstar baseball player for the Shady Valley Primadonnas. His efforts contribute to the production of a

highly valued entertainment product. Although he works only six months each year and usually only a few hours a day, he is paid millions of dollars for his productive services. In contrast, George Grumpinkston, an economics professor at the Ambling Institute of Technology, works longer and harder for twelve full months of the year. However, the educational service that he provides is not has highly valued. As such, his annual income is measured in thousands of dollars, rather than millions. Factor Market Structures The structure of a factor market depends on the number of competitors on the demand side, which determines the market control of each firm. This gives rise to four alternative market structures. Perfect Competition: This contains a large number of relatively small buyers, each with no market control. Monopsonistic Competition: This contains a large number of relatively small buyers, each with a small degree of market control. Oligopsony: This contains a small number of relatively large buyers, each with extensive market control. Monopsony: This contains a single buyer with complete control of the demandside of the market. If a factor market is perfectly competitive such that the buyers have no market control, then inputs are paid a price exactly equal to the value of their contribution to the firm, that is, marginal revenue product. However, if the buyers have any market control, then the inputs are paid a price less than the value of their contribution to the firm. A curve that graphically illustrates the relation between marginal product and the quantity of the variable input, holding all other inputs fixed. This curve indicates the incremental change in output at each level of a variable input. The marginal product curve is one of three related curves used in the analysis of the shortrun production of a firm. The other two are total product curve and average product curve. The marginal product curve plays in key role in the economic analysis of short-run production by a firm. The marginal product curve illustrates how marginal product is related to a variable input. While the standard analysis of short-run production relates marginal product to labor, a marginal product curve can be constructed for any variable input.

Marginal Product Curve The diagram to the right graphically represents the relation between marginal product and the variable input. This particular curve is derived from the hourly production of Super Deluxe TexMex Gargantuan Tacos (with sour cream and jalapeno peppers) as Waldo's TexMex Taco World restaurant employs additional workers. The number of workers, measured on the horizontal axis, ranges from 0 to 10 and the marginal Gargantuan Taco production of each extra worker, measured on the vertical axis, ranges from 0 to 30. The shape of this marginal product curve is worth noting. For the first two workers of variable input, marginal product increases, as each added worker contributes more to the total production of Gargantuan Tacos than previous workers. This increasing marginal product is reflected in a positive slope of the marginal product curve. Beyond the third worker, the marginal product declines, as each added worker contributes less to the total production of Gargantuan Tacos than the previous worker. This decreasing marginal product is seen as a negative slope. The marginal product eventually declines until it reaches zero and even becomes negative. This results as the marginal product curve cuts through the horizontal axis. The hump-shape of the marginal product curve embodies the essence of the analysis of short-run production. The upward-sloping portion of the marginal product curve, up to the third worker, is due to increasing marginal returns. Decreasing marginal returns sets in after the marginal product curve peaks with the second worker and declines for the third worker. In particular, this declining segment of the marginal product curve reflects the law of diminishing marginal returns. Bargaining theory: The bargaining theory of wages was pronounced by John Davidson in 1989. According to him , wages are determined by the relative bargaining power between workers / trade unions and employers and basic wages, fringe benefit, job differentials and individual differences tend to be determined by the relative strength of the organization and trade union.

 The exponent of bargaining theory are of view that thee should be upper and lower limits for the rate for the given type of labour. The wage paid within this range depends on the relative bargaining power of labour and employees. The greatest weakness of this theory of wages is its failure to define the limits precisely of to estimate the range between them. The upper limit is that rate above which the employer will refrain to hire a certain group of workers. The lower limit is the rate below which worker refuse to work. According to Walton and McKerise, identified four bargaining sub-processes such as: Intra - organizational bargaining Distributive bargaining Integrative bargaining Attitudinal bargaining Criteria of wage fixation Salary or wage means all remuneration (other than remuneration in respect of over-time work) capable of being expressed in terms of money. Wages are defined broadly as any economic compensation paid by the employer to his labourers under some contract for the services rendered by them. In its actual sense which is prevalent in the practice, wages are paid to workers which include basic wages and other allowances which are linked with the wages like dearness allowances, etc. , but does not include(i) Any other allowance which the employee is for the time being entitled to; (ii) the value of any house accommodation or supply of light, water, medical attendance or other amenity or of any service or of any concessional supply of food grains or other articles; (iii) Any traveling concession; (iv) Any Bonus (including incentive, production and attendance bonus);

(v) Any contribution paid or payable by the employer to any pension fund or provident fund or for the benefit of the employee under any law for the time being in force; (vi) Any retrenchment compensation or any gratuity or other retirement benefit payable to the employee or any ex gratia payment made to him; (vii) Any commission payable to the employee Wage criteria enable an employer to arrive at a decision to choose one out of possible wage levels. Several authorities have provided tabulations of wage criteria. Lester, in his study, obtained from employers opinions as to which factors were most important in setting wage levels. They are in order of importance: Wage rates paid by other firms in the area or industry Union pressure Changes in cost-of living Shortage or surplus of qualifies labour Employee unrest The companys finical position Profit of the company Another author Slichter lists seven wage criteria The minimum necessities of workers The changes in the cost of living The maintenance of take-home pay in the face of reduction in hours The changes in the productivity of labour The ability of the employer to pay The alleged effect of higher or lower wages upon consumer purchasing power and employment The wages paid in other industries or places.