Nature of Compensation

Compensation is what employees receive in exchange for their contribution to the organization. Generally employees offer their services for their types of rewards. Pay refers to the base wages and salaries employees normally receive. Compensation types such as bonuses, commissions and profit sharing plans are incentives designed to encourage employees to produce results beyond the normal expectation. Benefits such as insurance medical, recreational, retirement etc. represents a more indirect type of compensation. So, the term compensation is a comprehensive one including pay, incentives and benefits offered by employers for hiring the services of employees. In addition to these, managers have to observe legal formalities that offer physical as well as financial security to employees. All these issues play an important role in any HR department’s efforts to obtain maintain and retain an effective workforce.
Compensation offered by an organization can come both directly through base pay and variable pay and indirectly through benefits.
Base pay: It is the basic compensation an employee gets, usually as a wage or salary.
Variable pay: It is the compensation that is linked directly to performance accomplishments (bonuses, incentives, stock options).
Benefits: these are indirect rewards given to an employee or group of employees as a part of organizational membership (health insurance, vacation, pay, retirement pension etc.).
Objectives of Compensation Planning:
The most important objective of any pay system is fairness or equity. The term, equity has three dimensions
1) Internal equity: This ensures that more difficult jobs are paid more.
2) External equity: This ensures the jobs are fairly compensated in comparison to similar jobs in the labour market.
3) Individual equity: It ensures equal pay for equal work. i.e. Each individual’s pay is fair in comparison to others doing the same /similar jobs.
In addition there are other objectives also. The ultimate goals of compensation administration (the process of managing a company’s compensation program) is to reward desired behaviours and encourage people to do well in their jobs. Some of the important objectives that are sought to be achieved through effective compensation management are listed below:
1) Attract talent: Compensation needs to be high enough to attract talented people. Since many firms compete to hire the services of competent people, the salaries offered must be high enough to motivate them to supply.
2) Retain Talent: Compensation levels fall below the expectations of employees or are not competitive, employees may quit in frustration.
3) Ensure equity: pay should equal the worth of a job, similar jobs should get similar pay. Likewise more qualified people should get better wages
4) New and desired behaviour: Pay should reward loyalty commitment, experience, risk taking initiatives and other desired behaviours. Where the company fails to reward such behaviours employees may go in search of greener pastures outside.
5) Control costs: The cost of hiring people should not be too high. Effective compensation management ensures that workers are neither overpaid nor underpaid.
6) Comply with legal rates: Compensational programs must invariably satisfy governmental rules regarding minimum wages, bonus, allowance benefits etc.
7) Ease of operation: The compensation management system should be easy to understand and operate. Then only will it promote understanding regarding pay related matters between employees’ unions and managers.
Equity and Pay rates:
The need for equity is the most important factor in determining pay rates. This is achieved through the followings steps:
1) Find the worth of each job through job evaluation.
2) Conduct a salary survey to find what other employees are paying for comparable jobs.
3) Group similar jobs in to pay grades.
4) Price each pay grade by using wage curves.
5) Fine tune pay rates.
Source: HRM Book

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