UNIT V

COMPENSATION
MANAGEMENT
Compensation
• Compensation is the total reward received by an employee
in exchange for services performed for an organization.
• It is the payment made by the organization to employees
for lending their time, energy, skills, knowledge,
commitment, etc.
• It is the remuneration received by an employee in return to
his/her contribution to the organization.
• All employees work for a certain purpose and hence their
efforts need to be compensated. So, compensation deals
with all forms of pays or rewards paid to employees raised
from their employment.
• It can be basically divided into two types:
• Direct compensation (basic pay, incentive pay,
stock options, commissions, bonuses, etc)
• Indirect compensation (flexible working
schedule, elder care, retirement programs,
moving expenses, health & life insurance, paid
leaves, tickets to events, magazine
subscriptions, transportation facilities,
clothing & boots, laundry services, child care,
etc)
• Employee compensation refers to all forms of
pay or rewards going to employees and arising
from their employment.
-Thomas Pattern Jr.
• Compensation refers to a wide range of
financial and non-financial rewards to
employees for their services rendered to the
organization.
-T.N.Chhabara
• Every body wants something in return of their effort. No
body wants to work freely. So it is one of the critical
paths of human resources activity. Without
compensation employee won't be motivated towards the
work.
• Therefore, Compensation management may be defined
as the process of designing, implementing and
maintaining pay system which help to improve
organizational performance. It deals with designing
lowest cost pay structure that attracts, motivates and
retains competent employees and also perceived
fairness.
Purpose and Use of Compensation
• To attract potential candidates and reduce
turnover.
• To motivate and retain good and competent
employees.
• To administer pay within legal regulations.
• To facilitate organizational strategic objectives.
• For the sustainable growth of the
organization.
 Process of Compensation Management
• Performing job analysis: Analyze the job roles, responsibilities and
the competency need to perform particular tasks. A job is evaluated
to determine its value relative to all other jobs and then converting
the relative job value into compensation (monetary value).
• Conducting pay surveys: Conducting survey to identify how other
firms are paying in terms of salary and benefit on similar kind of
job; and determining the pay structure on the basis of survey.
• Analysis of organizational problems: Many other variables can
easily affect wage structure in the company. Organizational status,
business condition, impact for other fringe benefits, etc.
• Preparation of pay structure: Preparing pay structure after
determining the outcomes from job analysis, pay surveys and
understanding organizational problems.
• Framing pay administration rules: After determining compensation range,
its rules and regulations; compensation policy or pay system has to be
fixed. Rules and regulations should be developed on following areas:
– Trade off between seniority and merit basis
– The frequency of pay increases
– How to control salary and wage costs
• Implementation of wages and salaries: After determining pay scale, and
developing compensation policy, rate of salary and wages must be
implemented by the authorized executives in the company.

In this whole process, HR department plays vital role on determining pay

scale in the company. HR provides advice and suggestions to the executives
or compensation implementation committee to determine salary and
wages. In general, HR department may review the whole implementation
process. HR department must ensure the compliance with the established
rules, policies and pay structures.
 Methods of Employee Compensation

• Base plus cost of living allowance (BCOLA)

• Scale plus cost of living allowance (SCOLA)
• Cash Incentives
• Bonus or variable pay
• Broad banding method
• Job or skill based pay method
• Merit pay method
• Other terms of compensation
• Base Plus Cost of Living Allowance (BCOLA): This method is based
on two factors. Base Salary and Allowance. Every organizations has
their base salary for all employees with cost of living allowances.
Cost of Living Expenses is an adjustment to the base salary by a
percentage that is assumed to match increases in cost of goods &
services on a national regional or in local level.
• Scale Plus Cost of Living Expenses (SCOLA): This is also a popular
method of providing compensation. Organization set one scale for
particular level of job and they add cost of living expenses. Also, in
this method, Cost of Living Expenses is an adjustment to the base
salary by a percentage that is assumed to match increases in cost of
goods and services on a national regional or in local level.
• Cash Incentives: In this method, one of the above method (BCOLA
or SCOLA) is used and with an addition compensation to motivate
and reward employee on exceeding performance goal in the
organization.
• Bonus or Variable Pay: Salary and allowance is used (BCOLA or
SCOLA) as a core pay, and in addition Bonus is paid on achieving
group or an individual performance goal in the organization.
• Broad Banding Method: Broad Banding is collapsing salary grades
and ranges into just a few wide levels (or bands) each of which
contains a wide range of jobs an salary levels. It created vertical pay
rate range. Example is government of Nepal pay plan. Pay level from
level 1 to level 11 with grades.
• Job or Skill Based Pay: This method is also very popular in recent
years. It is may be because of higher demand of skillful employees.
Every individual will get different pay based on individual’s skills and
competency.
• Merit Pay Method: This method is also popular, and majority of
organizations globally are using this method. In this compensation
system, base pay increases by determining by the performance level
of employee.
 Compensation and Incentives for
Management Employees
• Executives play an important role to maintain economic health of the
organization, and as they are important for the success, growth and
profitability of the company, they have to be compensated properly.
To make executives happy, companies have been giving more value
to the executives by making a good compensation and incentives
plan. That includes:
 Medical Care (including the family of executives)
 Facilities for entertaining customers and for dining
 Company recreational services
 Cost of training and education for development
 Well furnished accommodation
 Vehicle facility (loan, installment, or full payment)
 Components of an executive compensation Plan
• The components of an executive compensation plan is different between
company to company. Components of an executive compensation plan
are:
• Basic Salary: The standard wage paid to an executive that typically is the
largest share of an annual compensation package.
• Bonuses (Short-term incentives): Distributions for annual milestones or
reaching incentivized goals that are typically cash-based.
• Long-term incentives: Grants or awards for long run, where the payment
is based on performance for a period beyond one year.
• Benefits: Non-cash compensation provided to an employee on an annual
basis. These typically include elements like health and life insurance,
defined benefit or contribution plans, and paid vacations to the
executives.
• Perquisites: Privileged grants to employees in addition to their other
compensation. These can include everything from a company car to a
business-paid cell phone, apartments, food etc.
Issues in Management Compensation Plan
Executive Committee has assumed considerable importance in recent
years. They are increasing ever year and has become public comment. This
issues covers three major aspects:
1.What and how much the executives paid?
2.Why are they paid heavy remuneration?
3.What issues are involved in payment of higher remuneration?

The reasons are:

 Executives receive salaries, bonus, commissions, stock, potions and perks;
and this is differ from country to country. And they are paid very high in
most of the cases, and this is first issue.
 Executives are one of the team of very talented people in the organization,
and to retain them, organizations pay high to them.
Job Evaluation Concept
• Job evaluation is a systematic approach of
evaluating, or rating or valuing the job in term
of its worthiness.
• Job evaluation is determining each jobs worth
or importance in the comparison of all other
jobs of the organization and preparing a job list
in hierarchical order.
• Such comparison is made and compensation
determining on following basis:
• Job evaluation is a process of determining the
relative worth of various jobs within the
organization, so that different wages may be paid
to jobs of different worth.
-Wendell French
• By job evaluation, we mean using the
information in job analysis, to systematically
determine the value of each job in relation to all
jobs in the organization.
-DeCenzo & Robbins
Job Evaluation Process (System)
• Preliminary Planning: This process define whether to conduct job
evaluation formally or informally. Formal evaluation is relatively
systematic application of standards and decision rules to rank jobs,
and it is longer and costly process. Informal evaluation is just
opposite to it. It also includes who should perform job evaluation.
• Selecting Job Evaluation Plan: Identifying the actual method to
evaluate job for compensation plan. (JE methods are ranking,
grading, point method and factor comparison method).
• Developing the Plan: In this plan, a job hierarchy is developed by
comparing the various jobs against specified standards using the
predetermined process of job evaluation.
• Evaluating Job: Job can not be adequately evaluated without
accurate and up to date information about job responsibilities. (job
analysis and job description helps on evaluating jobs).
 Job Evaluation Methods
• Non-analytical methods (Non-quantitative)
 Ranking method
 Job classification or grading method
• Analytical methods (Quantitative)
 Point (rating) method
 Factor comparison method
• Non-analytical methods (Non-quantitative)
 Ranking method: It is a simple method of JE. Under this method committee is
constituted consisting of management and employee representative to arrange jobs
in a simple rank order from highest to lowest. Jobs are compared to each other
based on the overall worth of the job to the organization. The worth of a job is
usually based on the judgments of skills, physical & mental efforts, responsibility and
working conditions.
 Five steps are involved in this step: 1) Preparing JD, 2) Rater Selection, 3) Benchmark
Jobs, 4) Ranking all the Jobs, & 5) Preparing job Classification.
Advantages:
 Quite simple and easy to understand.
 Most suitable method for small size organization.
 Does not require much cost. Hence, less expensive.
 Less time consuming. Only few forms are to be filled up by the rater.
Disadvantages:
 There is possibility of bias judgment in ranking of jobs.
 It does not measure relative differences between jobs.
 It is unmanageable for large number of jobs.
 It only gives rank but does not specify the degree of importance attached to each
job.
• Non-analytical methods (Non-quantitative)
 Job classification or grading method: This method is an improvement over
ranking method. According to this method, a predetermined number of job
groups or job classes are established and jobs are assigned to these
classification. This method places groups of job into job classes or job grades
such as executives, skilled, semi-skilled, unskilled or class I, II, III, etc. Each class
is assigned a salary range with maximum and minimum limits.
Merits:
 This method is quite simple and can be easily understood by the employees.
 It is less costly & is suitable for organizations where number of jobs is small.
 It is most suitable for government organization than in private industries.
Demerits:
 Job grade descriptions are vague and are not quantified.
 It is rigid, so it is not suitable for organizations having varied work.
• Analytical methods (Quantitative)
 Point or Rating method: Under this system a manual is prepared highlighting the
various factors such as education, skill, competence, knowledge, training,
responsibility, job conditions, complexity, hazards, coordination, physical and mental
efforts, mechanical ability, etc. The comparative weight of these factors against each
other determines the degree of their importance. The suitable point value is then
assigned to each factor. The job is then evaluated on the basis of sum total of these
points contained in it. The main focus out here is points instead of pay rates.
Merits:
 It provides numerical base for determining wage differentials.
 It is a systematic method of job evaluation.
 It makes possible to place jobs in different categories.
 It is more suitable method where large number of job exists ie. In large organizations.
Demerits:
 It is highly expensive method & hence it is not suitable for small organization.
 It is time consuming. To determine job factors and their comparative advantage
consume a lot of time.
 Assigning point value to the factors is also difficult.
 It is not simple to understand.
• Analytical methods (Quantitative)
 Factor comparison method: It is mostly used in evaluating professional and
managerial positions. It is the combination of ranking & point methods. Each
job is ranked for each compensable factor separately. Each job factor is
broadly defined. The most common factor used in job evaluation includes
skills, physical and mental requirements,, working conditions &responsibility,
and other such factors (solving abilities, accountability, etc).
Merits:
 It is systematic, more accurate and quantifiable method of evaluating manual,
clerical and supervisory positions.
 It is easy to understand and explain.
 The plan does not require a translation form points to money.
Demerits:
 It is highly expensive system of job evaluation.
 It does not consider all the compensable factors of a job. Only the common
factors are considered.
 Performance Base Pay (PBP)
• When the pay is based on whether the target or objectives are
achieved by the employee, is said to be a performance based
pay. In this system, the top performers are given attractive
reward, and poor performers targeted for elimination.
• Therefore PBP is highly important to establish quantifiable and
measurable objectives, based on which an employee can be
rewarded adequately.
• Employers generally use this method to evaluate how well the
employee works and thus they set the salary for that particular
position. Standard based methods have been in fact used for
many years now among the commission based sales employees.
Salespersons receive more for selling more and low performing
salespersons are not able to earn enough.
 Challenges of Performance Base Pay

• Designing the effective PBP system in the

organization
• Limitation of organizational decision to
implement PBP system
• Organizational financial strengths (can
organization afford PBP?)
• Identify the actual performance base for the
job (role) etc.
Strategic Purpose (Importance) of PBP
Major purpose of PBP is to attract and retain talents in the organization.
If pay is going to influence employee performance, two sets of
condition must exist:
Strategic Purpose (Important) for Employees
Employee must perceive the relation between performance & pay
Pay must be important to employees
The employees must be able to perform extra work
Performance must be measurable and fair
Organizational Responsibilities for Strategic PBP
Create trustworthiness between organization and employees
PBP must be understandable to employees
Performance appraisal method must be free from potential bias
The amount of money to be paid to extra output must be sufficiently
large to make extra effort
 Employees Benefits: Incentive Systems

• Incentive means direct compensation for

performance. So, they are monetary benefits paid to
employees for outstanding performance. It helps to
attract the capable employees and retain them for
longer period of time. It will also increase the earning
of employees if they perform better.
• Incentive plans provide financial or non-financial
rewards to employees who make substantial
contributions to organizational effectiveness.
-Wendell French
Developing Incentive Plan (System)
• Establishing minimum job rates
• Establish performance standards
• Determine incentive rates
• Establish process for changing standards (if
conditions changes)
• Try out the incentive plan on an experimental
basis
• Communicate and implement the plan
 Types/Forms of Incentive Pay Plans (IPPs)
• Individual incentive plans
– Piecework plan
– Commission plan
– Bonus plan
• Group incentive plans
– Piecework plan
– Commission plan
– Bonus plan
• Organizational incentive plans
– Profit sharing plan
– Scanlon plan
– Suggestion plan
– Employee share ownership plan (ESOP)
• Individual incentive plans: This plan is directly related towards the
performance of individual employee. But for this plan individual
performance should be measurable.
 Piecework (piece rate) plan: In piece rate plan, incentive is given to
production workers on the basis of their individual performance. The
compensation is based on the number of units produced. It can be of two
types: straight piece work (where worker is paid fixed wage for each unit
produced. There is direct relationship between output and earnings) and
differential piece work (where workers are paid on tow rates. One rate is
given for standard output and another higher rate is given for output above
the standard)
 Commission plan: This is given to an individual in sales activities for his/her
outstanding performance. It can be of tow types: Straight commission &
salary plus commission.
 Bonus plan: This is given to managerial and professional employees for
meeting specific individual performance goal. It is based on cost saving. It
can be spot bonus, end-of-year bonus, production bonus, etc.
• Group incentive plans: According to this plan, incentives are
determined for specific group of workers for their mutual
contribution or achievements. Such group incentives are
determined where individual contribution to goal attainment
cannot be measured or where completion of an individuals
task depend on the contribution of another individual.
 Piecework plan: This incentive goes to the group of
production workers exceeding the performance standard.
 Commission plan: This incentive goes to the employees who
are engaged in selling activities.
 Bonus plan: It is given to a group of managerial or
professional employees.
• Organizational incentive plans: It includes those benefits and service to
employees that are given in case of excellent organizational performance. Such
benefits go to almost all the organizational members according to certain
criteria.
 Scanlon plan: It is given to workers for organizations overall benefits arising out
of productivity enhancement schemes, time and labour saving schemes, all
resulting in the reduction of overall cost and increase in overall profit. It
emphasizes employer-employee participation and sharing in the operations
and profitability of the company.
 Profit sharing plan: Employers share some portion of organizations profit with
its employees. It has importance in the sense that it makes workers feel
belonging to the organization and having claim on organizations profit as well.
Main forms of profit sharing plans are:
 Current distribution (where some % of net profit is distributed among workers)
 Deferred distribution (where some portion of organizations profit is credited in
individuals account in which may later be withdrawn by the concerned
employee or under certain conditions such as retirement or termination)
 Suggestion plan: Such incentives are given to workers for benefits arising out
of schemes or plans based on good suggestion of the workers regarding cost
reduction, quality improvements, safety enhancement, finding new
opportunities, or work processes. Suggestion plan improves the
communication process between management and employees. Employees are
participated as a member to provide suggestion which may be helpful to an
organization. This incentive is provided to employees when they give new
useful ideas for improving organizational effectiveness.
 Employee share ownership plan (ESOP): In order to make workers sense of
belongingness to the organization and sense of ownership, management can
decide to declare different incentives in the form of:
 Installment purchase (employees are given opportunity to buy organizations
share on the basis of installment payment)
 Stock option (employees are given opportunity to buy company’s share within
specific period or the benefits that organization has decided)
 Gift (employees are given shares as gift as a part of their share in organizations
profit sharing plan)
 Employee Benefits and Services
• The purpose of employee benefits is to increase the economic
security for employees, and help organization to retain employees.
There are different types of benefits. Some are mandatory by law,
and other differ from organization to organization. Such benefits
plan are: Pension, Gratuity, PF, Insurance, Medical, Paid Vacation,
Refreshment, Team Building, Accommodation, Food, Vehicle etc.
These different benefits can be categorized into the following
types:
 Economic / Financial Benefits (sick, health, old age, etc)
 Recreational / Social Services (benefits for free hours)
 Professional Services (counseling, legal, education etc)
 Family Welfare Services (family welfare and convenience)
Emerging Issues in Compensation Management
Issues in Pay Planning In Nepal

• Issue of minimum wages (setting standard)

• Issue of comparable worth
• Issue of pay secrecy (no transparency)
• Issue of inflation and salary compression
• Issue of cost of living differentials
• Issue of pay reviews (not review on time)
• Issue of employee participation in pay design
• Issue of performance base pay
• Issue of Union influence in compensation plan
 The Issue of Minimum Wages:
• Due to slow industrial and economic growth, there is always excess of
labor supply over its demand. Therefore the bargaining power of workers
in Nepal is very low. The wage in Nepal is defined considering the inflation
rate, and our wage structure is lowest in south Asia.
The Issue of Comparable Worth:
• It refers to the requirement to pay equal wages for jobs of comparable
value to the employer . The concern is should women who are performing
jobs equal to the men’s be paid same as men? Almost all semi government
and government institutions are paying equal, but some private
organizations in Nepal are not practicing this.
The issue of Pay Secrecy:
• Most of the private organizations are not making their pay and incentives
transparent and this is done to avoid pay comparison among employees.
Government and semi government organizations are making their pay
structure transparent, and family run organization prefer pay secrecy.
 The Issue of Cost of Living Differentials:
• Different country have different standards of cost of living index. Even in
Nepal living in Kathmandu and living in Terai region have different cost of
living, and not maintaining this standard is an issue in Nepal. Company in
Nepal needs to differentiate the cost of living standard for different region.
The Issue of Pay Review:
• Pay must be reviewed and changed from time to time, but how frequent
and when becomes a relevant issue. Pay review must be made on
predetermined dates. For example, every year on first of Shrawan. But pay
review system in Nepal is based on political leader’s announcement rather
then a system base.
Not Participating Employees for Pay Plan:
• In Nepalese context, pay review committee do not involve employees to
determine pay structure. Issue will be solved if involve mgmt. employee.
Issue of Inflation and Salary Compression:
• Most of the organizations in Nepal do not adjust salary on the basis of
inflation rate. Government need to adjust salary yearly based on inflation
rate
 Government Regulations of Compensation
Structure in Nepal
• Legal environment and pay system governance in Nepal
is not satisfactory enough. Compensation structure
developed from following components in Nepal:
 The Legal Environment
 Pay System Governance (institutional framework)
 Pay Practice in Nepal
 Provision Related to Minimum Wage
 Social Welfare, Incentive Provisions and Retirement
Benefits Nepal Acts.
 The Legal Environment:
• Government legislation related to pay plans a vital role in determining
pay structure practice of an enterprise. Important acts directly or
indirectly related to pay system in Nepal are:
a. Labour Act 2048 and Labour Regulation
b. Bonus Act
c. Company Act 1996
• One of the objectives of these regulations compensation policy and
system of an individual organization or government organizations.
 Labour Laws: Labour law has made several provisions relating to pay
policy, remuneration and welfare. This laws maintain no discrimination,
fixes minimum wages, PF, OT payment, etc.
 Bonus Act: Payment of bonus is mandatory to the companies only that is
both public ltd. and Pvt. Ltd. The bonus act has prescribed 10% of net
profit as the limited for bonus payment.
 Pay System Governance (institutional framework):
• To implement pay policy, regulations and directives government has formulated
institutional framework. Some important bodies are:
a. Department of Labour(DOL)
b. Wage Boards
c. Pay Commission/Committee
d. Labour Court
Pay Practices in Nepal
• Pay Practices in Nepal differ according to the nature of the organization,
management philosophy, legal provisions, productivity and union pressure among
others. There are different pay practice in different types of organizations in
Nepal.
a. Pay Practices in Government Organizations (GOs)
b. Pay Practice in Private Sector Organizations (PSO)
c. Pay Practices in Private Bank and Financial Institutions
d. Pay Practices in Non-Government Organizations (I/NGO)
 Provisions Relating to Minimum Wages
• Most of the problems in industrial relations in Nepal come from
wage issue. A study of the causes of industrial disputes unfolds that
nearly two third of the disputes in Nepal occurred due to workers
dissatisfaction with wages and fringe benefits. There are certain
provisions in Nepal related to minimum wages.
Social Welfare, Incentive, and Retirement Benefits
• Social welfare which the organization offers in an organized way
against certain risks to which workers are exposed such as sickness,
maternity, old age, death. It provides social assistance.
• Social welfare includes the certain of family responsibility of the
organization, and organization tries to cover –Medical care in terms
of illness, maternity facility, paternity facility, pension during
inability, pension in the old age, lay off allowance etc.