Basics of compensation management

By Supreet Ahluwalia Corporate Consultant & Trainer

Components of Compensation system:

The literal meaning of compensation is to counter-balance. In the case of human resource management, compensation is referred to as money and other benefits received by an employee for providing services to his employer. Money and benefits received may be in different forms-base compensation in money form and various benefits, which may be associated with employee's service to the employer like provident fund (12% employee & 12% employer), gratuity(2.5% of basic salary per month or salary of 12 months / 12 = average monthly salary then average monthly salary / 30 = average 1 day salary x 21 = gratuity for present year), and insurance scheme, and any other payment which the employee receives or benefits he enjoys in lieu of such payment. Cascio has defined compensation as follows: "Compensation includes direct cash payments, indirect payments in the form of employee benefits and incentives to motivate employees to strive for higher levels of productivity

Various components of compensation

Based on description (in above slide) of compensation, we may identify its various components as follows: Wage and Salary: Wage and salary are the most important component of compensation and these are essential irrespective of the type of organization. Wage is referred to as remuneration to workers particularly, hourly-rated payment. Salary refers to as remuneration paid to white-collar employees including managerial personnel. Wages and salary are paid on the basis of fixed period of time and normally not associated with productivity of an employee at a particular time. Incentives: Incentives are the additional payment to employees besides the payment of wages and salaries. Often these are linked with productivity, either in terms of higher production or cost saving or both. These incentives may be given on individual basis or group basis. Fringe Benefits: Fringe benefits include such benefits which are provided to the employees either having long-term impact like provident fund, gratuity, pension; or occurrence of certain events like medical benefits, accident relief, health and life insurance; or facilitation in performance of job like uniforms, Canteens, recreation, etc. Perquisites: These are normally provided to managerial personnel either to facilitate their job performance or to retain them in the organization. Such perquisites include company car, club membership, free residential accommodation, paid holiday trips, etc.

Basic factors in determining pay rates

Employee compensation refers to all forms of pay going to employees and arising from their employment. It has two main components, direct financial payments (wages, salaries, incentives, commissions and bonuses). And indirect financial payments (financial benefits like employer paid insurance and vacations).

Components of Employee compensation

Two main components of Employee compensation

Direct financial payments

Indirect financial payments

wages, salaries, incentives, commissions and bonuses

financial benefits like employer paid insurance and vacations

 In turn, there are basically two ways to make direct financial payments to employees: base them on increments of time, or on performance.
Two ways to make direct financial payments

Increment of time

Increment on performance

 Time based pay is still the foundation of most employers pay plans. Blue collar and clerical workers get hourly or daily wages for instance and others. Like managers or Web designers tend to be salaried and paid by the week, month or year. The second direct payment option is to pay for performance. Piecework is an example. It ties compensation to the amount of production (or number of pieces) the worker turns out. For instance, you divide a workers target hourly wage by the standard number of units he or she is to produce in one hour. Then for each unit wage he or she produces, the person earns the calculated rate per piece. Sales commissions are another example of performance based (in this case, sales based) compensation. Of course employers also devise pay plans in which employees receive some combination of time based pay plus incentives.

 Several factors determine the design of any pay plan: legal, union, company policy etc.

Legal considerations in Compensation

Employee compensation systems around the world operate within the framework of legislations. Fair compensation for work is an integral component of decent work as defined by the ILO. In India also various legislations influence the structure computation and payment of compensation wages). Generally the non managerial level of employees and a section of workers in the informal sector of economy are covered by wage legislations. The important wage related legislations are the Minimum Wages Act of 1948, the Payment of Wages Act of 1936 and the Equal Remuneration Act of 1976. Separate legislations have been enacted to cover bonus payment, retirement benefits, and social security benefits to employees in the formal sector.

Companies Act of 1956

The companies Act of 1956 sets the framework for remuneration of top management of Indian companies. Till 1991, an upper ceiling of Rs 15,000 per month existed for top managerial remuneration. Similarly there were caps on profit sharing and payable perquisites. The limits were later relaxed. Under section 198 of the act, the total remuneration payable to directors including managing directors (MDs) and whole time directors of publicly listed companies in any financial year should not exceed 11% of the net profits of the company. Further Section 309 (1) of the act requires the board of directors to fix the remuneration of directors. The remuneration committee one of the subcommittees of the board of directors of a firm, has the task of playing a key role in determining the salary structure of full time directors and senior management

 A Pay Commission is a panel of members of the Union Cabinet of India for review and revision of the salaries of government employees. It was set up by the Central Government in the year 1965, as an administrative committee to determine the salaries of central government employees. Six pay commissions have been set up till date.

The first pay commission

The first pay commission was constituted in May 1946 - The first pay commission was based upon the idea of living wages to the employees. The commission emphasised on the idea of the living wages and stated that the government which is going to introduce the minimum wages legislation for the workers of the private industry should also follow the same principle for its own employees. The commission basically recommended that the lowest rung employee should at least get minimum wages.

The second pay commission

The second pay commission was set up in August 1957 - It stated that the pay structure and the working conditions of the government employee should be crafted in a way so as to ensure efficient functioning of the system by recruiting persons with a minimum qualification.

The third pay commission

The third pay commission set up in April 1970 - The third pay commission went beyond the idea of minimum subsistence that was adopted by the first pay commission. The commission report say that the true test which the government should adopt is to know weather the services are attractive and it retains the people it needs and if these persons are satisfied by what they are getting paid.

The Fifth Pay Commission

The Fifth Pay Commission was set up in 1994. With the implementation of the Fifth Pay commission a huge burden was taken up by the central government. It declared hike in salary of central government employees. Further, it also insisted on pay revision at the state government level.

The sixth pay commission

In July 2006, the Cabinet approved setting up of the sixth pay commission. This commission has been set up under Justice B.N.Srikrishna with a timeframe of 18 months. Almost all the Government employees received 40% of the pay arrears in the year 2008 and balance 60% arrears (as promised by Government) has also been credited in Government employees account in the year 2009

The end