COMPENSATION MANAGEMENT (ASSIGNMENT - 1)

WAGE THEORIES

1. ECONOMIC/ CLASSICAL / SOCIAL WAGE THEORY

a. Subsistence theory

Subsistence theory for determination of wages: this theory was given by Ricardo and based on
two assumptions:

i) Law of diminishing returns

ii) Rapid increase in population.

As per this theory there should be minimum limit of wages below which labor supply will not be
available. If the workers were paid more than the subsistence wages their number would increase
and this would bring down the rate of wages and if the wages fall below the subsistence level, the
number of workers would decrease. Thus the natural price of labor is that price which is necessary
to enable the laborers one with another to subsist their race without either increase or decrease.

b. Wage fund theory for determination of wages:

 This theory was given by Adam Smith and further expounded by J. S. Mill. This theory is based on
the assumption that the wages are paid out of predetermined fund. If the fund is large wages would
be high and if the fund is small wages would be reduced to the subsistence level. The demand for
laborer depends upon the size of the fund and wages depends upon the demand of labor. Thus to
increase the wages first the wage fund should be increased than the number of workers should be
reduced.

c. Surplus value theory:

 This theory was developed by Karl Marx. As per this theory the price of the product is determined
by the labor time needed to produce it and the surplus goes to be utilized for paying other expenses.

2. JUSTIFICATION THEORY

a. Marginal productivity theory: 

This theory was developed by Henry Wicksteed and John Clark. According to this theory wages
are depend upon the demand and supply of labor. Workers are paid as per what they are
economically worth.

b. Bargaining theory: 

This theory given by John Davidson. As per this theory wages are determined by the
bargaining power of the workers and of the employers. This is possible in big organizations
where labor is well-organized.

c. Purchasing Power Theory

The purchasing-power theory of wages concerns the relation between wages and
employment and the business cycle. It is not a theory of wage determination but rather a theory
of the influence spending has (through consumption and investment) on economic activity. The
theory is based on the assumption that changes in wages will have a significant effect on
consumption because wages make up such a large percentage of the national income. It is
therefore assumed that a decline in wages will reduce consumption and that this in turn will
reduce demand for goods and services, causing the demand for labour to fall.Purchasing Power
Theory • If wages fall more rapidly than prices, labour’s real wages will be drastically reduced,
consumption will fall, and unemployment will rise—unless total spending is maintained by
increased investment, usually in the form of government spending.Conversely, if wages fall less
rapidly than prices, labour’s real wages will increase, and consumption may rise. If investment
is at least maintained, total spending in terms of constant dollars will increase, thus improving
employment.It should be noted that the purchasing-power theory involves psychological and
other subjective considerations as well as those that may be measured more objectively.

d. DEMAND AND SUPPLY THEORY (Given by MARSHALL)

This theory is given by Marshall. He assumed the whole set of factors which govern demand for
and supply of labour affected the determination of wages. It is therefore necessary to understand
the various factors, which influence the demand for and supply of labour. The employers’ demand
for labour is dependent on a number of factors such as the demand for his/her product, availability
of other factors of production (the most important being the supply of capital), the level of
technological progress, etc. The demand price of labour is determined by the marginal productivity
of individual worker.

e. COMPARATIVE ADVANTAGE THEORY

Economists specializing in international trade argued about countries, industries and companies
competing on the basis of comparative advantage of cheap labour Employers are known to
move to areas where labour is cheap, be it within a country or across countries. Subject to
internal and external constraints, labour also tends to show a tendency to move to areas, which
pay higher value for their skills and effort. In recent years, however, there is pressure on
countries and companies competing on the basis of cheap labour to ensure compliance with
minimum core labour standards concerning minimum age, freedom of association, right to
collective bargaining forced labour and non-discrimination.

3. BEHAVIOURAL THEORIES

Behavioral theories are divided into three categories:-

a. Content theories
b. Process theories, and
c. Contemporary theories
a. CONTENT THEORIES

The content theories explain what inspires manpower at their jobs. Maslow, Hergberg and Alderfer
gives their significant contribution to content theories. These are as follows:-

I. HIERARCHY OF NEEDS:

Abraham Maslow proposed the first theory called the hierarchy of needs theory. He proposed five
needs of any people in needs hierarchy physiological or basic need (food, shelter, clothing), safety
need (emotional and physical safety – health insurance, pension), social need (affection and
belongingness to society), Self-esteem need (power, achievement, status, etc.), and self-
actualization (personal growth, realization of potential). Maslow believed that within every
individual, there exists a hierarchy of five needs and each level of need must be satisfied before an
individual pursues the next higher level of need. As an individual progresses trough the various
levels of needs, the proceeding needs loose their motivational value.

II. TWO FACTOR THEORY OF MOTIVATION:

Herzberg extended work of Maslow and developed a specific content theory of work
motivation. Factors of this motivational theory divided into two categories:Intrinsic cand
Extrinsic. Interinsic factors are the motivators (satisfiers) for the workforce and, Exterinsic
 factorsar the hygiene factors (dissatisfiers). Intrinsic remuneration are motivators or satisfiers
work for satisfy workers related to job content. It includes success, identification,
responsibility, work enrichment, and works enlargement. Extrinsic remuneration are hygiene
factors and helps to reduce the dissatisfaction on the job. It includes company rules regulation
and administration, supervision, co-ordination, salary structure, interpersonal relations, working
environment

III. ERG THEORY:

Clayton Alderfer identified 3 groups of core needs; they are- Existence, Relatedness and
Growth.

(a) The existence needs are concerned with survival.

(b) The connected needs and the importance of interpersonal and social relationship.

(c) The growth needs are concerned with individual’s intrinsic desire for personal development.
Based on a person’s background and social environment, one set of needs may precede over others.

The job of Maslow, Hergberg and Alderfer are related to content theories. They give useful theories
but have limited implications for policy and practice.

IV. EQUITY THEORY

J. Stacy Adams, developed by equity theory,

Equity can be stated in two elements. One is internal and other is external. Internal equity states
that the imbalance in the remuneration between the several skills or talent and responsibility level
among the various manpower. Internal equity is determined through job evaluation.

External equity states that when remuneration levels for same skills levels in one organization
compare with other workers in any different organization in same industry and geographical region.
External equity is determined usually through compensation surveys or interview and
compensation satisfaction surveys. 

1. Agency Theory: This theory states that both the employer and the employee are
the stakeholders of the company, and the remuneration paid to the employee is the
agency cost. The employee will try to get an increased agency cost whereas the
employer will try to minimize it. Hence, the remuneration should be decided in such a
way that the interest of both the parties can be aligned.
Thus, these theories posit that the compensation in the form of salary or wages can be
decided on the basis of the outcome or the behavior of an employee.

 Edwin Locke put forward the Goal-setting theory of motivation. This theory states that goal setting is essentially
linked to task performance. It states that specific and challenging goals along with appropriate feedback contribute
to higher and better task performance.

In simple words, goals indicate and give direction to an employee about what needs to be done and how much
efforts are required to be put in