VARIOUS CONCEPTS OF COMPENSATION

Wages is any monetary compensation paid to an employee for the

services he/she renders. Primarily, wages in any form provide financial
support for the labour, or it is a price paid for the labour. In
organizations, wages are divided into two broad categories: base wages
and other benefits or allowances. Benefits or allowances are essentially
made available to prevent the erosion of wage income in real terms. The
basic salary is the real wages and the basic salary with allowances
represents money wages. Some of the allowances, however, are statutory
in nature. Good organizations, however, voluntarily pay more allowances
over and above the statutory requirements.
Although we make the distinction between the terms wages and
allowances; in India various Acts related to labour administration,
defined the term wages differently. The only commonality in the
definitions of wages provided by different Acts is that in all the cases
definition of wages includes also the dearness allowances. The
Workmen's Compensation Act, 1923, Section 2 (m), defines wages
considering the wages for leave period, holiday pay, overtime pay,
bonus, attendance bonus, and good conduct bonus. The Payment of
Wages Act, 1936 section 2 (VI) considers wages as any award of
settlement and production bonus, if paid, constitutes wages.
The legal connotations, therefore, do not consider alignment of wages or
compensation with the performance of employees.
Traditional theory of wages emphasize on its determination based on the
market forces, i.e., the demand and supply. The theory of negotiated
wages on one hand, considers the basis of wage determination through

the collective bargaining process. On the other hand, performance-based

wages or compensation emphasize on determination of wages based on
employees performance. From the economic perspectives, we find
marginal productivity theory, subscribes to wage determination based
on the estimate of value that will probably be produced by the workers.
At least in this case, we find certain trace of wage determination is
somewhat related to the performance level of employees. Performancebased compensation design emphasizes on the individual work, i.e., the
value of the individual employees performance to the organization.
BENEFITS OF PERFORMANCE-BASED COMPENSATION
From compensation management point of view, performance management
systems help in achieving following critical goals:

It helps in recognizing the efforts and contributions of employees

objectively and thereby facilitates in effective job pricing, both through
cost optimization and rewarding of talented performers.

It facilitates in suitable compensation design, rewarding employees based

on the performance linkage.

It supports employee motivation (which leads to increased performance),

helping employees to receive their performance feedback, understanding
their strengths and weaknesses. Employees can develop themselves
through self-introspection and thereby feel intrinsically motivated. So also
performance-based pay helps in getting extrinsically motivated. Both the
motivational constructs lead to improved performance.

It facilitates employees to develop their core faculty of goal achievement.

It retains good performers, through competitive compensation design,

offering increased flexibility to earn more, based on performance level.

It attracts good performers from competing organization.

PERFORMANCE-RELATED PAY
Introduction of performance-related pay in many organizations is difficult, as it
directly conflicts with the structured pay systems. In many organizations, it is
also observed that the violation of principle of seniority-based compensation
leads to the stagnation of many senior level employees, who get demotivated for
stagnation in their pay scales. Such de-motivation lowers their level of
performance and many such employees gradually leave the organization. Steel
Authority of India (SAIL) lost many of their senior level employees when they
launched their voluntary retirement scheme (VRS), for not getting the seniority
protection in pay scales. The same thing happened in case of the State Bank of
India. In both the cases, the private steel plants and the private sector banks got
immensely benefitted for ready-to-use manpower.

Another crude operational issue is designing incentives, aligning with the

performance, without specifying any minimum performance requirement. It
means every one become eligible for the incentives, as individual contributions is
not factored in designing the compensation. While 100 per cent factoring of
individual performance is not desirable (as it culminates conflicts), total
ignorance of it is also not desirable. Performance-linked compensation in such
cases provide for incentives for results that exceed the stated goals, combining
individual, departmental, and organizational goals.

In order to reap the strategic benefits of pay for performance, many

organizations limit the increase in the pay only to bare statutory minimum, while
increasing the amount of salary for those who are good performers. In both the
cases, compensation decisions are based on realistic assessment of
performance. Thus in such cases, organizations do away with the traditional cost
of living and seniority precepts for compensation design. However, such
practices have both advantages and disadvantages. Advantages are it rewards
the merit, improves the teamwork, provides job satisfaction, and finally achieves
the desired results. Disadvantages are difficulty to institutionalize the systems
and monitor it, difficulty in identifying appropriate performance evaluation tools,
and dilution of loyalty of employees (as it ignores the seniority factor).

PERFORMANCE-RELATED PAY
The term performance-related pay (PRP) encompasses several company wide
schemes, like employee participation and share ownership schemes, etc. and
general linkage with the compensation which the employees get. PRP schemes
are designed and administered based on a view of what the businesses needs
are. It often fails to deliver because it is not aligned closely to business strategy.
Secondly, performance-driven compensation can support constant change and
performance improvement, but they can't deliver these by itself contrary to

popular belief. Third, line managers can muddle the process, unless they get the
help.

Despite such difficulties in implementing PRP, organizations adopt this. We have

listed some of the important areas, which deserve attention from the
organizations, while they implement PRP.

Competition and Cost Control: Performance-related pay enhances corporate

performance in a competitive environment. When we link performance and pay
together, we also expect employees to behave accordingly. For example, when
organizations compete with customer satisfaction, we expect employees to focus
on this aspect, ensuring quality of goods and services.

Individualization: Collective relationships in a workplace are a common

organizational pursuit to achieve teamwork. PRP is essentially driven by an
individualization agenda. We can de-collectivize the workplace and the employer
relationship by individualizing things, particularly through the reward
mechanisms. Also we can use PRP in teamwork, i.e., in social partnership. The
problem emerges; when organizations go for merit only pay increases, i.e., the
extreme form of compensation individualization. Hence, effective PRP requires
organizations to balance both the individualization and the collectivization.

Mismatch with the Strategy: Organizations adopt various strategies, depending

on their business priorities. A common cost minimization strategy requires
different range of behaviours. Although there exist possibilities or co-existence of
different compensation programmes for different functions and divisions in the
same organization, time dimensions may conflict with each other. Short-term
focus, individual effort, and so on needs to be supported by a compensation
policy, which is different from long-term focus. Hence, effectively organization
has to select PRP, keeping pace with the strategies.

Monitoring and Evaluation: This is really important and organizations often lack
in this. It is not enough to just introduce PRP systems; it is also important to
understand how PRP actually benefits the organization. Tracking changes after
introduction of PRP through an effective monitoring and evaluation system can
do this.

Culture: PRP often runs into conflict with the organizational culture.
Organizations, which support diversity and pursue principles of equity, may not

find it easy to implement, as PRP makes differentiation in pay packages on merit

criteria. Many organizations give priority on quantitative achievement of results.
However, some functions may demand high quality of performance. Quality
cascades customers satisfaction. Again organizations compensation culture
may assign maximum weights on the fixed component, reducing variables to a
bare minimum. Incentives and other variables also may be at a fixed proportion,
depending on hierarchical levels, independent of functional domains. Hence
designing PRP compatible with organizational culture may again be difficult.

Use of PRP as an Instrument of Management Control: Many organizations wrongly

use PRP as an instrument of management control, pay-roll control, or
performance control. But this is not the right approach. In true sense, an
effective PRP can help in empowering employees. But using PRP as a control
mechanism defeats such pursuit. Again in teamwork systems, linkage between
the basic pay and team contribution hardly exists. We have many interesting
team performance bonuses and gain sharing schemes. Thus organizations must
use PRP for strategic benefits and not as a tool for control mechanism.

Problems in Monitoring the PRP

PRP clarifies employees what they are expected to do in their jobs. Organizations
embracing PRP should always try to set jointly clear targets and goals, which are
stretching, challenging, and achievable. However, it is also important to make it
monitor able. PRP initiatives of organizations often go wrong because they are
too complicated and line managers don't know how to operate them. Often in
organizations line managers are not communicated properly. Line managers fail
to make any connection between the PRP and the things they need to manage,
i.e., their business priorities. Thus to facilitate effective monitoring, organizations
need to train the line managers so that they can understand its basics and job
correlation. In many organizations, it becomes a perennial trade union issue also.
Once it is understood properly, it can be monitored effectively.

Selection of Appropriate Performance Appraisal Tools

PRP initiatives can also fail due to wrong selection of appraisal tools. Many
organizations assign overweight to such factors, on which employees hardly
have any control. Some of the policies of the organizations may limit the extent
of customer services. But such deficiencies may have some adverse effects on
customer satisfaction, onus of which, organizations may wrongly assign to the
individual employee, which PRP systems even stretch to link with the customers
feedback.

Perceptual Differences Between the Managers and the Employees

Employees often perceive senior managers compensation is disproportionately
higher, hence PRP in reality deprives them from their genuine pie, and while
benefits the senior managerial employees, as their contributions are more
traceable. To obviate such apprehensions, it is essential to communicate to the
employees the mechanism of PRP design, so that they can also trace their
contribution and matching compensation.