compensationOne of the most difficult functions of human resource management is that of determining the rates of monetary compensation. It is not only complex, but significant both to the organisation and employees. Employee compensation decisions are crucial for the success of an organisation. From a cost perspective alone, effective management of employee compensation is critical because of the total operating costs 


The main problem facing any organisation is the laying down a fair and equitable compensation system. While the objective is simple, the process is complex. For instance, the employer will be concerned primarily with productivity. The employee’s emphasis may be on higher compensation to offset their increased cost of living and perhaps the price his skill will fetch in a competitive job market. The compensation issues commanding most interest today and likely to continue in future will centre around questions of compensation levels and compensation structures. Obviously, this will raise questions concerning the level of compensation rates in the plant or firm, industry, region, or nation.

Closely related to this is the broad question of the determinants of compensation relationships. This involves an understanding of various influences controlling compensation, the nature of decision-making bodies and the different traditions and customary attitudes that have developed in individual firms or industries. In some cases, the controlling influences may be standards and mores of a particular locality or region, sudden change in technology, source of labour supply, firm’s competitive standing, and general sales-and-profits prospects of the industry.

A decision about compensation rates in a given situation has to be reconciled with a variety of considerations such as when pay rates should be changed and by how much, how they should be distributed among the different employees, and what firms should be covered. Disputes between employers and unions over wages and salaries are often a part and parcel of conflicts over such diversified matters.

One of the considerations in formulating a pay package is the quantum of take-home pay, that is the net packet, after an employee has paid for his deductions. Some of these deductions are savings for old age, like the provident fund and pension schemes. The balance between what is received now and what he will get on retirement is something that is variable in each case. In an employee’s earlier years, normally, children’s education, medical treatment, recreation will necessitate a larger income. In his later years an employee will need to provide for his old age, in terms of a house and a steady income to maintain his habituated life style. Another related issue is salary and tax planning. In this context, organisations have taken recourse to fringe benefits, some of which are taxable. The incidence of tax, either on money incomes or on the total taxable income including perquisites, has to be worked out. 


The compensation function contributes to the organisational effectiveness in four basic ways:

1) Compensation can serve to attract qualified applicants to the organisation. Other things being equal, an organisation offering a higher level of pay can attract a larger number of qualified applicants than its competing units.

2) Compensation helps to retain competent employees in the organisation. Although retaining competent workers is contingent on many factors, compensation policies help by maintaining a fair internal pay structure and by providing attractive benefits. Turnover is thus reduced, along with costs associated with recruiting, selecting, and training replacements.

3) Compensation serves as an incentive to motivate employees to put forth their best efforts. Manufacturing and sales organizations, for example, use monetary incentives to attain higher levels of production or sales without hiring additional employees. When employees put forth their best efforts, average productivity of labour increases. With increased productivity, fewer employees are needed to achieve the same level of output. Thus, labour costs are reduced and organisational profitability is increased.

4) Minimising the costs of compensation can also contribute to organisational effectiveness since compensation is a significant cost for most employers.

In brief, compensation is provided for two reasons, namely; as a reward for past service to the enterprise, and as stimulus to increased performance in the future.


The aim of compensation statement is to set down the company’s policy with regard to salary. It is the responsibility of all concerned to implement the compensation policies and to explain the same fully to their subordinates. The compensation policy should aim:

1) To recognise the value of all jobs in relation to each other within the company.

2) To take account of wage rates paid by companies of similar size, product and philosophy.

3) To ensure stable earnings.

4) To enable individuals to reach their full earning potential as far as is reasonably practicable.

5) To ensure employees’ share in the company’s prosperity as a result of increasing efficiency.

The objectives of any compensation system are numerous and might include the following:

1) To enable the employee to earn a good and reasonable salary or wage.

2) To pay equitable sums to different individuals, avoiding anomalies.

3) To reward and encourage high quality work and output.

4) To encourage employees to develop better methods of working and their acceptance.

5) To discourage wastage of materials or equipment.

6) To encourage employees to use their initiative and discretion.

7) To discourage overtime working unless it is very essential. 


The primary purpose of compensation administration is to assure management a sound compensation system, and for employees an equitable compensation for services rendered. The objectives of a sound compensation administration programme can be subdivided into specific sub-goals:

1) Equitable payment in proportion to relative work to the organisation.

2) Consistency of payments between comparable occupations.

3) Adjustment of payments in relation to changes in the labour market.

4) Recognition of individual capability and proficiency.

5) Comprehension of the plans by supervision and management.

6) Procedures to solve compensation problems rationally.

D.S. Beach in his book Personnel, The Management of People at Work provides seven principles of compensation administration:

1) The enterprise should have a clear-cut plan to determine differential pay level in terms of divergent job requirements involving varied skill, effort, responsibility and working conditions.

2) An attempt should be made to keep the general level of wages and salaries of the enterprise in line with that obtained in the labour market or industry.

3) Adequate care should be taken to distinguish people from the jobs.

4) Irrespective of individual considerations, care should be taken to ensure equal pay for equal work depending upon flexibility of jobs – of course, variations may be permitted within a pay range.

5) There should be a plan to adapt equitable measure for recognising individual differences in ability and contribution.

6) Attempt should be made to provide some procedure for handling wage grievances.

7) Adequate care should be taken to inform the employees and the union, if any, about the procedure followed in determining wage rates.

If the first goal of attracting capable employees to the organisation is to be achieved, personnel must perceive that the compensation offer is fair and equitable. As a first step in the pursuit of equity, there should be established consistent and systematic relationship among base compensation rates for all jobs within the organisation. The process of such establishment is termed “job evaluation”. 


At the outset, it is important to distinguish between two related but different questions. First, one can ask what factors account for individual differences in pay within organisations. An extensive literature suggests that education, experience, performance, and other individual differences play some role. Also, product market and labour market play a crucial role in pay determination. 

Product Market

Pay levels of labour market and product market of competitors play an important role in determining pay levels. Dunlop (1957) argues that product market competition places an upper boundary on pay level because organisations in a particular industry “encounter similar constraints of technology, raw materials, product demand, and pricing”. Thus, an organisation will find itself at a competitive disadvantage in the product market if its labour costs exceed those of its competitors. The reason being such costs will ordinarily be reflected to some extent in higher prices for its products. For example, if Hindustan Motors has higher labour costs than Maruti Udyog, Hindustan Motors will have difficulty in providing the same quality of automobile at a competitive price. Consequently, product market pressures may act as an upper boundary on employee compensation.

Labour Market

Organisations not only compete solely in the product market but also in the labour market. Maruti Udyog, for example, competes for technicians and managers with similar such organisations. A pay level that is too low relative to these competitors could lead to difficulties in attracting and retaining sufficient number of quality employees. As such, labour market competition can be seen as placing a lower boundary on pay level. In order to avoid such a situation, many companies emphasise that their total compensation is equal to or better than other companies in the market. 


A compensation survey is a process of collecting data and facts about compensation policies, practices and programmes of companies in some labour market. It provides information that has many uses. This information is particularly relevant to the problem of establishing and adjusting salary levels. It may also be used to validate the compensation structure. The objectives of compensation survey vary from one organisation to another. Before conducting a compensation survey, an organisation should study the compensation data that are already available. If such information is not available, a company may either conduct its own survey or participate with other organisations in a cooperative effort.

The data collected through survey should include not only information on the key jobs and their comparability to the surveyed organisation’s jobs but also information on benefits, bonuses, and other methods of compensation besides direct salary. Failure to include these factors would give a distorted picture of the total compensation package offered. It is also useful to collect information on the characteristic of the organisation to determine how similar the organisation is to the one surveyed. In either case, great care must be given to compensation survey procedures.

Conducting a compensation survey is a complex, costly and time-consuming process. For this reason, employers should thoroughly examine existing compensation surveys before planning to conduct one of their own. Before deciding to use an existing standard survey, an employer should consider a number of factors. First, will the survey provide information to suit the organisation’s needs? If one survey does not meet an employer’s needs, perhaps several surveys will provide the needed information. Second, how representative are the surveyed organisations of those with which an employer wishes to make pay comparisons? Third, does the existing survey provide sufficiently detailed job descriptions to permit detailed comparison with jobs in one’s organisation?

There are three basic methods of conducting a compensation survey: Personal Interviews, Mail questionnaires, and Telephone interviews. The most reliable is the personal interview, even though it is time consuming and expensive. Compensation survey serves as a valuable tool for the compensation administrator to acquire useful and necessary information concerning industry pay structures and practices.


A sound compensation structure must be based on job evaluation programme in order to establish fair differentials in payments depending upon differences in job contents. Besides the basic factors provided by a job description and job evaluation, those that are usually taken into consideration for determining compensation structure are:

  • The organisation’s ability to pay
  • Supply and demand for labour
  • The prevailing market rate
  • The cost of living
  • Productivity
  • Trade union’s bargaining power
  • Job requirements
  • Managerial attitudes
  • Psychological and sociological factors 

The compensation structure must be linked to what the company is trying to achieve. It is not unusual to find a company with a wage structure in direct conflict with the company’s overall objectives. For example, a company may plan to produce a high quality product while at the same time, it may have a direct incentive geared to quality.

An attitude survey should be made to ascertain what needs have to be satisfied through a compensation structure. What are the employees’ attitudes towards the current pay structure and what are their deeper expectations? The pay structure, to a large extent, determines and reinforces attitudes. Two of the areas a survey ought to highlight are the reasons why employees work for a particular company, and what motivates them. 


Job evaluation is a method used to describe, analyse, compare and evaluate jobs within a unit, a branch, or an industry on the basis of the work content and the job requirements in order to place them under particular wage or salary grades. It is a systematic attempt which provides basis for comparing jobs and determines the relevant worth of different jobs in an organisation. It has two basic objectives: (i) to compare jobs and determine their level within each occupational group; and (ii) to compare jobs between occupational groups.

A number of specific goals may be derived from the basic objectives:

1) To provide a basis for more objective and rational wage structure.

2) To correct wage inequities, resulting from personal acquaintance, bargaining pressures, change, customs, and so forth.

3) To provide the means for the ranking of new and changing jobs.

4) To reduce pay dissatisfactions by providing procedures for appeals and for grievances and their redressal.

5) To provide basic information for wage negotiations and wage determination.

While job evaluation approaches are probably the most prevalent methods of establishing base pay, their usefulness like the usefulness of any management system depends on how well they achieve their objectives. Nevertheless, they have a role to play in the administration of compensation. It can provide, at least an internally justifiable wage structure for organisations. 


Although pay differentials must be sufficiently large to provide incentives, perceived inequity in pay structures may result in detrimental effects such as turnover, grievances, and decreased motivation to perform. Organizations also sometimes face a conflict between the goals of internal consistency and external competitiveness in designing their structures.

Lawler (1986) has argued that organisations need to focus greater attention on external competitiveness. He believes that an internal focus encourages employees to compare themselves with others within the organisation, rather than focusing on the real competition with other organizations. He also suggests that an internal focus results in employees focusing on promotions rather than performing well on their current job. Moreover, there is some belief that conflicts between external and internal equity may be resolved by increasing the pay scales of all jobs, irrespective of their competition in the labour market.

Various steps for creating pay equity are listed below:

1) Categorise employees by job. Fewer jobs are better because too many jobs can cause the compensation system to be cumbersome and difficult to administer.

2) Compare pay levels with that of the labour market. There are many compensation surveys available.

3) Manage internal equity. Managing internal equity is more important than external equity.

4) Link pay with job performance. Those employees who perform their jobs better should receive larger salary increases than those who do not.

5) Communicate the compensation system and how it works.

Companies often conduct formal or informal surveys of their competitors to get an idea of appropriate pay levels. This helps them to achieve external pay equity by comparing the differences that may exist among similar operations in a particular labour market. The external considerations when developing a compensation plan may include labour market conditions, cost of living, and economic factors. 


In modern business, executives hold the most pivotal place in an organisation. They play a major part in looking after the economic health of the company. As they are important for the success, growth and profitability of an organisation, they have to be compensated properly. To make the executives happy to the extent possible, companies have been giving in recent years, bigger and more frequent rises in salaries. The cumulative effect is that executive compensation cost is today a sizeable cost and rising cost. Companies have started looking at executive compensation more systematically and more proactively so that they can expect better performance from the executives.

For the higher management, salaries are influenced by the size of a company, by the specific industry, and in part by the contribution of the incumbent to the process of decision-making. The bigger the company, the greater is the compensation paid to the executives. Straight salaries, bonuses, stock purchase plans and profit sharing are used to compensate executives. In addition, executives are compensated for the various expenses incurred by them, for taxation takes away a major portion of their salary. Such payments are in the form of:

1) medical care;

2) professional service in legal and financial matters;

3) facilitates for entertaining customers and for dining out;

4) company recreational services;

5) the cost of education and training of executives, scholarships for their children, and allowances for professional magazines and books; and

6) free well-furnished accommodation, conveyance and servants. All these go under the head of perquisites.

A sound system of executive compensation is essential for a number of reasons, namely:

i) to attract the right kind of personnel;

ii) to retain the right kind of personnel;

iii) to motivate the right kind of personnel; and

iv) to get the best out of the right kind of personnel in the face of competition.

The absence of internal equity leads to dissatisfaction among executives. In organizations, there are disparities between compensation patterns. For whatever reasons, compensation practices are kept as guarded secrets by organisations. Surveys of compensation practices tells us among other things, that executive compensation practices are based on factors like traditions, technology, management beliefs and executive acceptance.

To be effective, executive compensation has to be seen as a whole, evolved for a situation and administered in letter and spirit. Essentially, an executive compensation system or scheme for an organisation has to be tailor-made. Also, it has to be reviewed and revised from time to time. Top management should develop an approach to compensation that accounts for internal as well as external equity. The executive compensation will succeed when the total package:

i) establishes sufficient levels of pay;

ii) provides internal and external competitiveness;

iii) supplies opportunity, security and status;

iv) maximises after tax earnings;

v) calls forth maximum effort; and

vi) makes the executive a much better performer both as an individual and as a team member both for today and for tomorrow. 


Individual organisations may have differences in their compensation system based on factors best suited to their perceived needs. However, some general compensation trends are evident, as given below:

1) Basic or consolidated salary continues to remain as the major component of compensation system.

2) Allowances may be linked to the salary as a percentage or by slabs, but preference is for flat amounts, which do not increase automatically.

3) Reimbursements of expenses incurred on company work will become limited, and in line to conform with the tax laws. Being actual in most cases, they will not be considered as part of the compensation, unless it is provided towards personal benefits.

4) Annual payments such as bonus or commission, leave travel are common features – some tax reliefs apply for the latter.

5) Benefits will comprise mostly unfurnished company owned or leased accommodation, use of company owned or leased vehicle, medical coverage, retiral benefits covering provident fund, pension or superannuation or gratuity, post retiral medical assistance, and easy loan schemes at low or zero interest rates for house building.

6) Employee stock option schemes – which have been popular in IT industry – are yet not extensively used due to their lesser share values, especially in the well established older companies.

7) Retiral benefits are important to many, whilst the younger generation and specially IT professionals, do not consider it as an advantage, unless the benefit value is available to them on moving to a new job.

8) Against the past practice of modest gradual increases applicable to all, the differential in performance is now being recognised during the review of performance. Often a salary freeze is being used for poor performance and substantial and varying increases to the good performer.

9) Emphasis on variable performance pay or bonus as a reward is increasingly becoming important and growing component of the compensation system.

10) From the earlier grade oriented compensation system within reasonable boundaries, compensation is now somewhat tailor made for specialist or key contributors to retain them in the very volatile job market.

11) Compensation review periods have become generally annual and sometimes frequent, as compared to three to five years earlier, in the fast changing market situation.

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