After studying this chapter, students should be able to understand the following:
A. Job Pricing & Developing a Base Pay System
B. Compensation system
We begin this chapter with an overview of compensation and an explanation of
compensation equity. Next,
we discuss determinants of individual financial compensation and the organization
as a determinant of
financial compensation. This is followed by a discussion of the labor market,
the job, and the employee, as
determinants of financial compensation. Finally, job pricing and executive compensation
To understand the basic concepts of compensation first of all we will define
Pay is a statement of an employee’s worth by an employer.
Pay is a perception of worth by an employee
HR Management Strategy Model:
Human resource department uses different
strategies to mange the workforce so that the
desired results can be attained. These desired
result as stated in earlier chapters as well, can be
attained if organization is able to attract, select,
develop and retain workforce in successful
manner in short, the effective hiring and
retaining workforce can be helpful in achieving
organizational goals. This purpose can be
attained through fair and effective rewards
systems in the organization. Rewards are used as
basic motivational tools in the organization so
that performance of the employees can be
influenced in desirable way. So to be more
successful organizations need attractive and fair
compensation and reward systems to be paid to
A. Job Pricing
Job pricing means placing a dollar value on the worth of a job.
I. Pay Grades—The grouping of similar jobs together to simplify
the job pricing process. Plotting
jobs on a scatter diagram is often useful in determining the appropriate number
of pay grades.
II. Wage Curve—The fitting of plotted points in order to
create a smooth progression between pay
III. Pay Ranges—Includes a minimum and maximum pay rate
with enough variance between the
two to allow some significant pay difference.
IV. Broad Banding—A technique that collapses many pay grades
(salary grades) into a few wide
bands in order to improve organizational effectiveness.
V. Single-Rate System—Pay ranges are not appropriate for
some workplace conditions. When
single rates are used, everyone in the same job receives the same base pay, regardless
or productivity. This rate may correspond to the midpoint of a range determined
VI. Adjusting Pay Rates—when pay ranges have been determined
and jobs assigned to pay grades,
it may become obvious that some jobs are overpaid and others underpaid. Underpaid
normally are brought to the minimum of the pay range as soon as possible.
B. Compensation: An Overview
i. Compensation—The total of all rewards provided employees
in return for their services.
ii. Direct Financial Compensation—Consists of the pay that
a person receives in the form of
wages, salaries, bonuses, and commissions.
iii. Indirect Financial Compensation—All financial rewards
that are not included in direct
iv. Non-financial Compensation—Consists of the satisfaction
that a person receives from the job
itself or from the psychological and/or physical environment in which the person
works. All such
rewards comprise a total compensation program.
I. Equity in financial compensation :
Organizations must attract, motivate, and retain competent employees. Because
achievement of these goals
is largely accomplished through a firm’s compensation system, organizations must
strive for compensation
a. Equity—Workers’ perceptions that they are being treated
fairly. Compensation must be
fair to all parties concerned and be perceived as fair.
b. External Equity—Exists when a firm’s employees are paid
comparably to workers who
perform similar jobs in other firms.
c. Internal Equity—Exists when employees are paid according
to the relative value of their
jobs within an organization.
d. Employee Equity—Exists when individuals performing similar
jobs for the same firm are
paid according to factors unique to the employee, such as performance level or
e. Team Equity—Achieved when more productive teams are rewarded
more than lessproductive
II. Determinants of individual financial compensation:
Compensation theory has never been able to provide a completely satisfactory
answer to what an individual
is worth for performing jobs.
• The Organization,
• The Labor Market,
• The Job, and
• The Employee
These all have an impact on job pricing and the ultimate determination of an
a. The Organization as a Determinant of Financial Compensation:
• Compensation Policies—An organization often establishes—formally
compensation policies that determine whether it will be a pay leader, a pay follower,
strive for an average position in the labor market.
1. Pay Leaders: Those organizations that pay higher wages
and salaries than competing firms.
2. Market Rate or Going Rate: The average pay that most
employers provide for the same job in a
particular area or industry.
3. Pay Followers: Companies that choose to pay below the
market rate because of poor financial
condition or a belief that they simply do not require highly capable employees.
• Organizational Politics—Political considerations may also
enter into the equation. A
sound, objective compensation system can be destroyed by organizational politics.
Managers should become aware of this possibility and take appropriate action.
• Ability to Pay—An organization’s assessment of its ability
to pay is also an important
factor in determining pay levels. Financially successful firms tend to provide
compensation. However, an organization’s financial strength establishes only
upper limit of what it will pay.
b. The labor market as a determinant of financial compensation:
Potential employees located within the geographical area from which employees
are recruited comprise the
• Compensation Surveys—Large organizations routinely conduct
compensation surveys to
determine prevailing pay rates within labor markets.
1. Compensation surveys: Provide information for establishing both direct and
2. Benchmark job: A job that is well known in the company and industry, one that
entire job structure, and one in which a large percentage of the workforce is
• Cost of Living—A pay increase must be roughly the equivalent
to the cost of living
increase if a person is to maintain a previous level of real wages.
• Labor Unions—When a union uses comparable pay as a standard
compensation demands, the employer must obtain accurate labor market data. When
union emphasizes cost of living, management may be pressured to include a cost-of-living
allowance (COLA). This is an escalator clause in the labor agreement that automatically
increases wages as the U.S Bureau of Labor Statistics’ cost-of-living index rises.
• Society—Compensation paid to employees often affects a
firm’s pricing of its goods
and/or services. Consumers may also be interested in compensation decisions.
• Economy—In most cases, the cost of living will rise in
an expanding economy. Thus, the
economy’s health exerts a major impact on pay decisions.
• Legislation—The amount of compensation a person receives
can also be affected by
certain federal and state legislation.
c. The job as a determinant of financial compensation:
Organizations pay for the value they attach to certain duties, responsibilities,
and other job-related factors.
Techniques used to determine a job’s relative worth include job analysis, job
descriptions, and job
• Job Analysis and Job Descriptions—Before an organization
can determine the relative difficulty or
value of its jobs, it must first define their content, which it normally does
by analyzing jobs. Job analysis
is the systematic process of determining the skills and knowledge required for
performing jobs. The job
description is the primary by-product of job analysis, consisting of a written
document that describes
job duties and responsibilities. Job descriptions are used for many different
purposes, including job
• Job Evaluation—That part of a compensation system in which
a firm determines the relative value of
one job compared with that of another.
d. The employee as a determinant of financial compensation:
In addition to the organization, the labor market, and the job, factors related
to the employee are also
essential in determining pay and employee equity.
I. Performance Based Pay—PA data provide the input for such approaches
as merit pay, variable
pay, skill-based pay, and competency-based pay.
1. Merit Pay: A pay increase given to employees based on
their level of performance as indicated in
2. Bonus: The most common type of variable pay for performance
and is a one-time award that is
not added to employees’ base pay.
3. Skill-based Pay: A system that compensates employees
on the basis of job-related skills and
knowledge they possess, not for their job titles.
4. Competency-Based Pay: A compensation plan that rewards
employees for their demonstrated
II. Seniority—The length of time an employee has been associated with
the company, division,
department, or job is referred to as
III. Experience—Regardless of the nature of the task, very few factors
has a more significant impact
on performance than experience.
IV. Membership in the Organization—Some components of individual financial
are given to employees without regard to the particular job they perform or their
V. Potential—Organizations do pay some individuals based on their
e. Political Influence—Political influence is a factor that
obviously should not be used as a determinant
of financial compensation. However, to deny that it exists would be unrealistic.
f. Luck—The expression has often been stated, “It certainly
helps to be in the right place at the right
time.” There is more than a little truth in this statement as it relates to the
determination of a person’s
g. Special Employee Classes—These include pay for executives,
which are discussed in a later section,
and pay for professionals and sales employees.
III. Executive Compensation:
Executive skill largely determines whether a firm will prosper, survive, or fail.
Therefore, providing adequate
compensation for these managers is vital. A critical factor in attracting and
retaining the best managers is a
company’s program for compensating executives.
a) Determining Executive Compensation—In determining executive compensation,
typically prefer to relate salary growth for the highest-level managers to overall
performance. In general, the higher the managerial position, the greater the
managers have in designing their jobs.
b) Types of Executive Compensation—Executive compensation often has
elements: (1) Base Salary, (2) Short-Term Incentives or Bonuses, (3) Long-Term
and Capital Appreciation Plans, (4) Executive Benefits, and (5) Perquisites.
The way an
executive compensation package is designed is partially dependent on the ever-changing
• Base Salary: Salary is obviously important. It is a factor
in determining standard
of living. Salary also provides the basis for other forms of compensation.
• Short-Term Incentives or bonuses: Payment of bonuses reflects
belief in their incentive value. Today, virtually all top executives receive
that are tied to base salary.
• Long-Term Incentives and Capital Appreciation: The stock
option is a
long-term incentive designed to integrate further the interests of management
with those of the organization. The typical
stock option plan gives the
option to buy a specified amount of stock in the future at or below the current
• Executive Benefits: Executive benefits are generally more
generous than those
received by other employees because the benefits are tied to their higher salaries.
However, current legislation (ERISA) does restrict the value of executive
benefits to a certain level above those of other workers.
• Perquisites (Perks): Any special benefits provided by
a firm to a small group
of key executives that are designed to give the executives something extra. A
“golden parachute” contract is a perquisite that protects executives
in the event that
their firm is acquired by another.
IV. Compensation for professionals:
People in professional jobs are initially compensated primarily for the knowledge
they bring to the
organization. Because of this, the administration of compensation programs for
professionals is somewhat
different than for managers. Many professional employees eventually become managers.
For those who do
not desire this form of career progression, some organizations have created a
dual track of compensation.
The dual track provides a separate pay structure for professionals, which may
overlap a portion of the
managerial pay structure.
V. Sales Compensation:
Designing compensation programs for sales employees involves unique considerations.
For example, job
content, relative job worth, and job market value should be determined. The straight
salary approach is at
one extreme in sales compensation. In this method, salespersons receive a fixed
salary regardless of their
sales levels. At the other extreme, the person whose pay is totally determined
as a percentage of sales is on
straight commission. Between these extremes, there are endless part salary–part
The possibilities increase when various types of bonuses are added to the basic
compensation package. In
addition to salary, commissions, and bonuses, salespersons often receive other
forms of compensation that
are intended to serve as added incentives.
Role of Line managers and HRM Department in Compensation:
Line managers perform the function of job evaluation that is base for the compensation
to the worth of the job negotiation regarding the salaries and other benefits
is negotiated with potential
employees through line mangers. Basic compensation packages are mostly recommended
by the line
managers in the organizations. All these information is communicated to the employees
department beside communicating this information HRM department also facilitates
the departments in
establishing rates of pay, monitoring in job evaluation process, and Conducting
salary surveys in order to
establish procedures for administering pay plans, and to ensure compliance with
Merit Pay: A pay increase given to employees based on their level
of performance as indicated in the
Equity: Workers’ perceptions that they are being treated fairly. Compensation
must be fair to all parties
concerned and be perceived as fair
External Equity: Exists when a firm’s employees are paid comparably
to workers who perform similar
jobs in other firms.
Internal Equity: Exists when employees are paid according to the relative
value of their jobs within an
Compensation: The total of all rewards provided employees in return
for their services.
Job Pricing: Job pricing means placing a dollar value on the worth
of a job.