NOTES ON COMPENSATION MANAGEMENT
Importance of Pay Pay represents by far the most important and
contentious element in the employment relationship, and is of equal
interest to the employer, employee and government
to the employer because it represents a significant part of his
costs, is increasingly important to his employees' performance and
to competitiveness, and affects his ability to recruit and retain a
labour force of quality; to the employee because it is fundamental
to his standard of living and is a measure of the value of his
services or performance; to the government because it affects
aspects of macro-economic stability such as employment, inflation,
purchasing power and socio-economic development in general.
While the basic wage or pay is the main component of
compensation, fringe benefits and cash and non-cash benefits
influence the level of wages or pay because the employer is
concerned more about labour costs than wage rates per se. The
tendency now is towards an increasing mix of fringe benefits, which
therefore have an important impact on pay levels. In industrialized
countries, and sometimes in countries with high personal tax rates,
the non-pay element of executive compensation has substantially
increased in recent years. Objectives of Pay Pay determination may
have one or more objectives, which may often be in conflict with
each other. The objectives can be classified under four broad
headings. The first is equity, which may take several forms. They
include income distribution through narrowing of inequalities,
increasing the wages of the lowest paid employees, protecting real
wages (purchasing power), the concept of equal pay for work of
equal value. Even pay differentials based on differences in skills
or contribution are all related to the concept of equity. A second
objective is efficiency, which is often closely related to equity
because the two concepts are not antithetic. Efficiency objectives
are reflected in attempts to link a part of wages to productivity
or profit, group or individual performance, acquisition and
application of skills and so on. Arrangements to achieve efficiency
may be seen also as being equitable (if they fairly reward
performance) or inequitable (if the reward is viewed as unfair). A
third objective is macro-economic stability through high employment
levels and low inflation, for instance. An inordinately high
minimum wage 1
would have an adverse impact on levels of employment, though at
what level this consequence would occur is a matter of much debate.
Though pay and pay policies are only one of the factors which
impinge on macro-economic stability, they do contribute to (or
impede) balanced and sustainable economic development. A fourth
objective is the efficient allocation of labour in the labour
market. This implies that employees would move to wherever they
receive a net gain; such movement may be from one geographical
location to another, or from one job to another (within or outside
an enterprise). Such movement is caused by the provision or
availability of financial incentives. For example, workers may move
from a labour surplus or low wage area to a high wage area. They
may acquire new skills to benefit from the higher wages paid for
skills. When an employer's wages are below market rates employee
turnover increases. When it is above market rates the employer
attracts job applicants. When employees move from declining to
growing industries, an efficient allocation of labour due to
structural changes takes place. The need for a Compensation
StrategyFor any / all of the following reasons: 1 To attract and
retain the best in the industry 2 To have compensation strategy
aligned to each business to better serve independent business needs
3 Should attract lateral hires 4 Need for greater flexibility in
taking compensation decisions 5 Need to align employee career
movement 6 Adding value through personnel costs GOALS OF A
COMPENSATION STRATEGY 1 Capable applicants are attracted towards
the Organization and it helps acquire qualified competent personnel
2 To retain current employees so that they do not quit If
compensation levels are not competitive, it will result in higher
turnover 3 Motivate employees to perform better 4 Encourage value
added performance Reward the desired behaviour 5 Control costs
Through a rational compensation system, employees can be obtained
and retained at a reasonable cost 6 Promoting continuous
development through competence related and skill based pay schemes,
effective performance management 7 Promoting teamwork through team
pay 8 Promoting flexibility by replacing hierarchical and rigid pay
structures 9 Providing value for money by evaluating the costs as
well as benefits of reward management practices 10 Facilitating
easy understanding by all, including employees, 2
operating managers and HR personnel 11 Providing value for money
by evaluating the costs as well as benefits of reward management
practices 12 Easy administration CHARACTERSTICS OF A SOUND
COMPENSATION STRATEGY 1 Be congruent with and support corporate
values, beliefs, philosophy and culture 2 Emanate from business
strategy and business plans (medium and long term) 3 Fit the
desired management style 4 Provide the competitive edge required;
be based on an industry benchmarking study 5 Be based on an
Organizations ability to pay 6 Be adaptable to changing business
conditions 7 Ensures Equity both internally and externally 8
Complies with the legal regulations as imposed by the government 9
Is effectively communicated 10 Careful selection of performance
measures, determination of performance awards and distribution
mechanisms 11 Union participation and involvement in designing the
policy to facilitate comprehension and acceptance 12 Provisions for
modifications and periodically reviewed A COMPENSATION STRUCTURE
COMMUNICATES 1 2 3 4 5 Organization Philosophy / Culture Career
Progression Benefits to Employees Individual v/s Team Focus
Performance Recognition giving the message to align Total
COMPENSATION with Business Situation, Needs & Goals 6 Generate
Flexibility / Variability of Costs 7 Focus on Effectiveness of
Total Compensation Policy FACTORS INFLUENCING COMPENSATION POLICY
Philosophy Organization Mission, Vision, Goals & Values
Inclination towards People Development, Attraction & Retention
of Talent Inter / Intra Level Relativity, Compa Ratio Assess
Competitiveness Current & Targeted Percentile Positioning
Budget Considerations
Parity Positioning Paying Ability
3
FACTORS AFFECTING COMPENSATION POLICY EXTERNAL FACTORS 1.
Parity: External equity (prevalent pay structures in industry /
geographic location) 2. Demand and supply: of labour and market
condition 3. Geographic location: cost of living and inflation
ORGANIZATION - RELATED 1. Philosophy: mission, vision, goals &
values inclination towards people development, attraction &
retention of talent, goodwill & organization culture 2. Parity:
internal equity (relevant differentiating factors performance,
seniority, skills, responsibilities, interpersonal abilities,
individual vs. Team vs. Organization roles) 3. Paying ability:
budget considerations / financial implications / limits of ability
to pay; business performance 4. Legalities: compliance of statutory
and government requirements 5. Trade unions: influence in
collective bargaining 6. Fringe benefits: statutory (overtime
payment, canteen subsidy, employee provident fund, gratuity) &
non-statutory (conveyance allowance, LTA, loans, insurance)
INDIVIDUAL RELATED 1. Job related: job requirements and internal
consistency 2. Competition: availability of special competent
personnel 3. Flexibility: due to varied levels of competencies and
skills of managers 4. Responsibilities: individual productivity and
performance / contribution to output 5. Individual assessment:
qualifications and relevant experience WHAT IS A COMPENSATION
SYSTEM Allocation, conversion, and transfer of a portion of the
income of an organization to its employees for their monetary &
in-kind claims on goods & services A Monetary claims are wages
or salaries paid to an employee in the form of money / or a form
that is easily and quickly transferable to money at the discretion
of the employee 1. Wages & salaries in the form of money could
be 2 types: present payments (earned & acquired at present
time) & deferred payments (earned but not acquired until some
future time) 2. Coins / paper money / cheques, credit cards 3.
Stock option plans / pension plans / post retirement income
adjustments In-kind claims are claims on goods & services made
available & paid for either totally or in some percentage by
the employer 4
B
in lieu of money provide an equivalent value for what has been
offered & received little or no immediate monetary gain
organizations purchase the usually desired goods & services to
take advantage of 1. Economies of scale available through group
purchasing 2. The benefits available through tax laws &
regulations 3. Government laws requiring certain services
NON-COMPENSATION SYSTEM Situation related rewards, related to the
physical & psychological well being of each employee, these
rewards satisfy the emotional & intellectual demands - Impact
on the intellectual, emotional & physical well-being of the
employee 8 DIMENSIONS OF COMPENSATION SYSTEM - PAY FOR WORK &
PERFORMANCE - money provided in short term (weekly / monthly /
annual bonuses & awards) - permits employees to pay for goods
& services desired - depends on: job requirements; outputs that
meet or exceed quantity, quality & timeliness standards;
innovations leading to improved productivity; dependability;
loyalty - includes: base pay, premiums & differentials, short
term bonuses, merit pay, travel expenses, clothing reimbursement
etc - PAY FOR TIME NOT WORKED - days off with pay for holidays,
longer paid vacations, election official, witness in court,
paternity leave, maternity leave, time off to vote, personal leave,
relocation payments, lunch & rest periods etc - although they
increase labour costs, but they enhance quality of work life
opportunities for most employees - LOSS-OF-JOB INCOME CONTINUATION
- job security is a prime consideration - loss of job could be due
to any of the following: * accident * sickness * personal
performance * interpersonal dynamics problems * firms decline / end
- unemployment insurance, supplemental unemployment benefits
(subs), severance pay, job contract etc help unemployed workers
subsist until new employment opportunities arise - DISABILITY
INCOME CONTINUATION - health or accident disability can lead to non
performance of normal assignments - family expenses persist -
social security, workers compensation, sick leave, travel accident
insurance, accidental death and dismemberment, short & 5
long-term disability plans are provided - DEFERRED INCOME -
providing income after retirement - includes social security,
pension plans, profit sharing (long term), stock option plans -
funds invested in these draw tax-free interest thus employees can
defer tax obligations - SPOUSE (FAMILY) INCOME CONTINUATION -
Providing dependents with income when an employee dies or is unable
to work due to total and permanent disability - life insurance
plans, social security, pension plans, workers compensation -
HEALTH, ACCIDENT AND LIABILITY PROTECTION - Income continuation
& payment for the expenses incurred for overcoming the illness
/ disability - wide variety of insurance plans available - medical,
hospital, surgical insurance (for self & dependents) - major
medical, dental & vision care. hearing aid, post-retirement
medical plans, prescription drugs, visiting nurse - liability
related insurance: group legal, group automobile, group umbrella
liability, employee liability - INCOME EQUIVALENT PAYMENTS - Perks
or perquisites - tax free: charitable contributions, giving of
gift, employee assistance programs, counseling, child adoption,
child / elderly care, subsidized food service, discounts on
merchandise, fitness programs, parking, commuting assistance
(transportation to & from work), fly first class, professional
memberships, professional journals, special relocation & moving
allowances, pay for spouse on business trips, home entertainment
allowance, domestic staff allowance, mobile phone, use of assistant
for personal services - Tax favoured: medical expense
reimbursement, chauffeur driven car, company plane / yacht, company
provided facilities, personal use of credit cards, vacation
accommodation, special loan arrangements, club membership,
concierge services DIMENSIONS OF NON-COMPENSATION SYSTEM Enhance
dignity and satisfaction from work performed - Least expensive
& most powerful rewards - Employee recognition leads to self -
worth & pride - Employees should feel that they are needed
& their efforts are being appreciated Enhance physiological
health, intellectual growth, and emotional maturity - Provide a
safe working environment: provision of safe equipment, risk free
environment, minimization of noxious fumes, avoidance of extreme
heat, cold & humidity conditions, elimination of contact with
radiation & other diseaserelated materials, reduced noise
levels, clean workstation, - stress & technological
advancements affect emotional well-being 6
of the individual: providing a stable & secure lifestyle,
training & development opportunities to overcome health-related
problems Promote constructive social relationships with coworkers -
an inexpensive & valuable reward is a work environment where
trust, fellowship & loyalty emanate from the top levels of
management, percolating to the grassroots - comradeship of
workplace associates - opportunity to develop productivity
promoting social relationships - moving towards team based
operations Design jobs that require attention and effort -
restructuring job tasks to make it challenging - sense of
accomplishment from work - job rotation to increase flexibility -
turning supervisors to mentors - making jobs more interesting &
less repetitive Organizations increase quality & productivity;
reduce employee turnover, absenteeism, tardiness, waste of physical
resources, theft & malicious damage Allocate sufficient
resources to perform work assignments - all necessary human,
technical and physical resources should be made available to
support & aid the employee in accomplishing the assignment -
the organization must enable employees to gain the required skills
& knowledge necessary to perform the assignment - organization
should do everything possible to assist the employee in completing
the assigned work successfully Grant sufficient control over job to
meet personal demands employee participation in decision-making
process casual dress day scheduling work activities flexible work
schedules: compressed workweeks, flextime programs, work from home
choice job sharing (2 part-time employees share 1 full-time job)
Offer supportive leadership & management employee faith &
trust in management skill & interest in coaching &
counseling of employees praise for a job well done constructive
feedback leading to improvement in job performance sufficiently
flexible leadership with policies, rules, regulations so that an
employee can meet job responsibilities without infringing on rights
& opportunities of other employees TRADITIONAL COMPONENTS OF A
COMPENSATION PROGRAM Fixed cash compensation - largest component of
the total compensation & rewards package - monetary
remuneration based on time worked & not on output / performance
- base wages & salaries depends on the internal value
(determined by job evaluation) & external value (through market
pay surveys) of employee 7
- after-tax paycheck - determines lifestyle of the employees -
leisure activities restricted / defined by the paycheck - most
critical part of the four components Wage & salary add-ons -
monetary remuneration - paid over & above the salary - includes
payments for working overtime, shift differentials, premium pay for
working on holidays / weekends - least critical of the four
components Incentive payments - pay- for - output system -
performance pay linked to both the company & the individual -
difficult to measure in the service industry which employs 70% of
the workforce of the total employed people - in several
professions, it is difficult to measure output & pay incentives
Employee benefits & services - hidden payroll or fringe
benefits - indirect financial & non-financial payments -
supplementary compensation totally dependent on organizational
philosophy - includes benefits provided by an employer to his
employees & his family (in some cases) - benefits for
employment security; health protection; old age & retirement;
personnel identification, participation & stimulation - two
types: mandatory employee benefits: voluntary benefits MANDATORY
EMPLOYEE BENEFITS Employer is compelled to provide for certain
benefits by the operation of the law Paid holidays factories act,
1948 a weekly paid holiday Paid vacations one day for every 20 days
worked Retrenchment compensation industrial disputes act, 1947 (one
month notice or one months pay) paid @ 15 days wage for every
completed year of service with a maximum of 45 days wage in a year
Lay-off compensation - industrial disputes act, 1947 (@ 50% of the
total of the basic wage & da for the period of their lay-off)
paid upto 45 days in a year Workmens compensation workmens
compensation act, 1923 payment to meet the contingency of
invalidity & death of a worker due to employment injury or
occupational disease Health benefits employee state insurance act,
1948 sickness benefit, maternity benefit, disablement benefit,
dependents benefit, medical benefit Canteen facility factories act,
1948 canteen in factories employing more than 250 workers Provident
fund contributions by employer & employee are 8.5% of basic
salary benefit payable on retirement, voluntary separation or death
Employee pension scheme introduced in 1995 employer 8
contribution is directed to pension + 1.66% of employee wages
contributed by central govt. Entitled to pension @ 1 / 70th of
salary for each year of service Gratuity after 5 years of
continuous service 15 days salary per year of service upto a
ceiling of INR 3,50,000/Companies with more than 10 employees Given
in case of separation, superannuation, death or disablement No
contribution of employees towards this benefit PSU scheme public
sector scheme Various pension schemes with accrual rates varying
from 1/100 to 1/60 Both employer & employee contribute
Membership is mandatory for all those in PSUs Leave encashment
scheme claim encashment of unutilized leave at the termination of
service Not-taxable in the hands of the retired employee Payable to
dependents in case of death of employee VOLUNTARY EMPLOYEE BENEFITS
Its is entirely the choice of the employer to provide these
benefits to the employees Shift premium for IInd & IIIrd shifts
for the odd hours Company housing accommodation some companies even
pay for the utility bills (electricity / water & society
charges) Subsidized food & transport Group mediclaim / personal
accident insurance adequate coverage for the hospitalization
expenses incurred due to illness, disease or injury sustained in
accident / pregnancy (for female) for employee & immediate
family dependents Educational facilities sponsor higher education
of employees & family members For certifications / trainings /
memberships etc co-operative credit societies for fostering
self-help than going to money lenders Legal aid provide legal
assistance & aid through company lawyers or others as &
when required Recreational facilities gyms, clubs, internet caf,
one film per week shows etc Regular meetings & gatherings of
employees with their families to express talent, creativity &
relieve of work stress Loans at subsidized rates of interests for
housing deposits, vehicle purchase, marriage, illness or death of a
close family member Personal health care extensive health check-up
periodically cellular phones / laptop on basis of business
requirement Corporate credit card to take care of official expenses
arising out of business trips Gifts on various occasions like
birthday, anniversary, festivals to strengthen bond between
employer & employee
9
TOTAL COMPENSATION
COMPENSATION STRUCTURE VARIOUS PERSPECTIVES
SALARY TRENDS AVERAGE SALARY INCREASE IN TOTAL COST TO COMPANY
(TCC) FOR THE YEAR 2006 ACROSS ASIA PACIFIC 14.0%
8.0% 5.5% 4.5%
8.0% 6.5% 3.5% 4.0% 4.5% 3.0% 7.0%
Australia
Malaysia
China
Philippines Hong Kong
Singapore
India
Taiwan
Japan
Thailand
Korea
10
1 Average salary hike in 2006 for India at 14%, making it the
highest in Asia Pacific 2 Employees in management staff cadre
received average salary hike of 16% in 2006 PERFORMANCE LINKED
AWARDS VARIABLE PAY TREND 1 Employee expectations are on the rise 2
Senior/ Top Management received the highest percentage of variable
pay in their compensation in the range of 17% to 30% 3 Variable Pay
increasing in year 2006 Banking Sector from 13% to 24% IT from 13%
to 18% Manufacturing from 10% to 16% FMCG from 14% to 18% PERCEIVED
BENEFITS 1 International Educational Advancement Program &
Tuition Reimbursement 2 Signing Bonus 3 Investment company makes on
Employee & Training imparted (National/ International) 4
OPPORTUNITIES OF LEARNING Early responsibility in career, freedom
at work and innovate 5 JOB PROFILE Work Content, Challenging
Assignments 6 CAREER PROSPECTS & GROWTH OPPORTUNITIES Growing
our own timber 7 FUTURE PLANS OF COMPANY Growing organization 8
TREATMENT OF PEOPLE Strong values of trust, caring, fairness and
respect within organization, healthy relationship at work. NEW
COMPENSATION APPROACHES Changing environmental pressures Three
changes having impact on organization structure & management
systems: Product markets have become global increased competition
in domestic & foreign markets Rapidly changing technology
greater need to employ technically & professionally skilled
workers keep their knowledge base & competencies current Fast
changing demographic composition of Workforce * higher age group of
employees, more women employees, rising level of formal education
11
Organizations response Major changes in organization structure
& management systems new model: flat, flexible, team-based,
participative, diverse, quality- focused, dynamic,
globally-oriented changes in the job from being specialized &
stable multidimensional horizontal growth of employees new
approaches to compensation & rewards FOUR NEW APPROACFHES TO
COMPENSATION SKILL-BASED PAY Employees are paid according to their
number of skills - skills are grouped in skill-blocks as an
employee acquires each block, his pay goes up - skill block
includes different types of skills: **breadth skills which focus on
all related jobs in an integrated production process **depth skills
which aim to increase specialization in a particular area
**vertical skills which are generally possessed by managers &
professionals Advantages to organizations a workforce is created
that can perform multiple tasks organization gets flexibility to
rotate employees & take care of organization menaces like
absenteeism, overtime, turnover, work-flow interruptions due to
production bottlenecks and variations in product demand better
problem solving capability improved productivity & quality of
services/ products stronger employee commitment employees become
familiar with the operations & tend to recognize the value
their own contributions Advantages to the employees acquire more
self-control over their own earnings develop greater capacity for
self-management experience more varied and enriched task
assignments these contribute to job satisfaction to a great extent
BROADBANDING Delayering of pay structure - a typical pay structure
consists of grades & ranges - a grade is a grouping of jobs
falling within a certain range of evaluation points - attached to
grades are pay ranges minimum to maximum spread * successively
higher grades will have higher minimum & higher maximum pay
rates - pay structure typically consists of a tall hierarchy of
narrowly defined grades, each with a relatively limited pay range *
such structures create in employees a strong motivation to 12
strive towards upward mobility as a means to obtain higher
compensation rewards Broadbanding is defined as - Consolidation of
existing pay grades into a small number of wide bands - results in
broad minimum-maximum pay spread for each band - compared to
conventional pay structures, broadband structures have fewer bands
& broader pay ranges - best suited to the needs of flexible,
flatter & performance-oriented organizations of today - Allow
flexibility in moving employees between jobs within a band without
formal job titles & pay grade changes - Flat structures place
increased emphasis on lateral career moves & skill development
that can be rewarded through broadbanding - Greater scope for pay
growth through within- band-pay increases than through promotions
to a higher band Example1 of how broad banding works Band I -
Executives, entry-level staff Band II - Sr. Executives,
supervisors, coordinators Band III - Assistant managers Band IV -
Managers, business managers Band V - General managers, national
managers Band VI CTO, CFO, CMO Band VII - President & CEO
Example2 of how broad banding works In a HR consultancy firm there
are 3 bands across the organization with a wide pay range in the
same band: - Entry level: requires good quantitative skills,
knowledge of basic MSOffice, ability to analyze & ability to
learn fast - Proficiency level: skills in project management,
problem-solving, resource management, thorough subject knowledge -
Mastery level: a leadership position requiring visionary skills
& ability to give direction to the organization To move up the
ladder, the employee needs to add value that would clearly separate
his accountability & key performance indicator *here
advancement means adding newer competencies VARIABLE PAY Defined as
- financially measurable reward paid to an individual based on his
overall performance - a powerful tool that enhances employee
productivity & performance TEAM REWARDS - These are awarded to
teams or groups based on their collective performance in achieving
the assigned targets - periodically targets are monitored to
encourage improved productivity & reward - provide each member
an opportunity to receive a bonus on the output of 13
the team a whole - most appropriate when jobs are inter-related
- generally payouts are determined by team rankings (based on
criteria like ratings by internal & external customers,
achievement of quarterly team objectives & the management input
recognizing special circumstances) - within same team also, all
members do not receive same payout it is subject to peer evaluation
- major problem in this is designing a model team-based pay system
Steps for setting up team rewards - Appraising teams - to evaluate
the performance of team against kras / preset targets - communicate
the results to ensure transparency - measure the performance of the
team (actuals vs. Targets) every month - rewarding teams - Make the
minimum level of performance the benchmark of team reward - make
team performance mandatory for individual rewards - distribute the
team reward in proportion to the basic pay of the grade to which
each team member belongs - build a geometric rate of progression of
the award for each successive target - link the individual award to
the basic pay of the grade to which the individual belongs VARIABLE
PERFORMANCE LINKED PAY (VPLP) The corporate buzzword today Becoming
a more common method for rewarding employees while linking their
performance more closely to the employers financial success Some
companies are allowing all levels of employees to participate in
these programs Variable pay is an innovative way to bring wages and
salaries in line with companies market performance A simple concept
thats based on rewarding employees for increased sales or
efficiency rewarding employees who increase productivity or
efficiency provides incentive for other employees who want to share
in the bounty rather than rewarding every employee with a pay raise
or bonus, variable pay rewards the individual worker, or a team of
workers, for extraordinary efforts Indian companies increasingly
adopting VPLP more than 85% organizations having VPLP Objectives /
Benefits of VPLP A powerful tool to enhance employee productivity
& thus impact bottomline align rewards to business goals build
a high-performing organizational culture 14
links overall compensation strategy with the organizations
business strategy helps differentiate between a mediocre & a
star employee a very effective motivational technique helps team
members understand their job expectations better a valuable
retention tool helps upgrade skills of team members by inducing a
competitive environment Types of Plans Individual Based Pay
Individual-based plans are the most widely used Of the
individual-based plans commonly used, merit pay is by far the most
popular - its use is almost universal - merit pay consists of an
increase in base pay, normally given once a year - supervisors
ratings of employee performance are typically used to determine the
amount of merit pay granted - once a merit pay increase is given to
an employee, it remains a part of that employees base salary for
the rest of his or her tenure with the firm Team based pay Normally
reward all team members equally based on group outcomes these
outcomes may be measured objectively or subjectively the criteria
for defining a desirable outcome may be broad or narrow as is less
commonly done in individual-based programs, payments to team
members may be made in the form of a cash bonus or in the form of
non-cash awards such as trips, time off, or luxury items Plant wide
/ company based pay Plant-wide or company-wide pay-for-performance
plans reward all workers in a plant or business unit on the basis
of the performance of the entire plant or business unit profit and
stock prices are generally not meaningful performance measures for
a plant or unit because they are the result of the entire
corporations performance most corporations have multiple plants or
units, a factor that makes it difficult to attribute financial
gains or losses to any single segment of the business - therefore,
the performance indicator most frequently used to distribute
rewards at the plant level is plant or business unit efficiency,
which is normally measured in terms of labor or material cost
savings compared to an earlier period or another plant or business
unit They are the broadest type of variable-pay incentive programs
Reward employees on the basis of the entire corporations
performance 15
the most widely used program of this kind is profit sharing.
Profit sharing is a company-wide pay-for-performance plan that uses
a formula to allocate a portion of declared profits to employees
typically, profit distributions under a profit-sharing plan are
used to fund employee retirement plans Features of VPLP Can be in
cash or kind generally offered in terms of extra perks as soft
housing loans, company cars, junkets abroad, mediclaim policies If
overall company performance is poor, SBU / team performance does
not warrant VPLP Largely, it does not exceed 30% of an executive s
annual pay Minuses of VPLP Recalculations in the case to reward
nonexempt (hourly) employees VPLP requires employers to include
certain types of variable compensation, such as bonuses, in
employees regular hourly wage rates as a result, companies that pay
variable compensation to nonexempt employees must often recalculate
employees regular hourly pay rates by factoring in the variable pay
the recalculation then affects the overtime pay calculations
employers who are designing variable compensation programs that
include nonexempt employees must be sure to review their programs.
failure to do so could cost significantly more in penalties and
payment of back wages Unspoken assumptions Several underlying
assumptions are behind the variable-pay concept, which derive from
the very nature of the society that we live in and are not
necessarily accurate: - money motivates people to work harder -
increased motivation will increase performance - fair measurement
of work performance is possible Money as a motivator there is no
doubt that money can be a powerful motivator however, it isnt
always Performance measurement motivation is clearly linked to
performance however, in many cases motivation is not the problem -
the performance problem may be due to lack of skills, poor
organization, bad strategy etc - measuring performance is difficult
and the most significant practical problem in VPLP - even harder to
manage is the problem of perception: even where there are real,
perhaps obvious, performance differences, the 16
employee who doesnt perform well is more likely to attribute his
or her low output to favoritism rather than performance
Implementation Failure of this motivational technique due to
inadequate planning poor implementation poor communication of
details of the scheme across the organization undefined evaluation
method individual objectives are not quantified for variable pay
calculation Effective implementation by -well defined individuals
& group targets -effective communication of the scheme to the
employees -commitment from the top -effective
performance-evaluation mechanism * simple, measurable performance
criteria that is understood by all -timely payouts Employers need
to do a better job of mapping individual employee performance and
linking it with compensation Conclusion To create and implement an
efficient variable-pay plan, an employer must make a commitment to
define employee expectations in behavioral and measurable terms -
This means making goals achievable, profitable, and practical for
both the company and its workers - the key to the success of
variable compensation is to have something you can measure and
understandsomething that is linked to creating economic value for
the company - instead of continually ratcheting up base pay,
manufacturing and service companies are adopting and expanding the
use of incentive compensation programs, at all levels, to reward
outstanding achievement without increasing fixed costs EVA
(Economic Value Added) It is a performance metric that calculates
the creation of shareholder value Eva is the calculation of what
profits remain after the costs of a company's capital - both debt
and equity are deducted from operating profit True profit should
account for the cost of capital Steps to calculate EVA: Calculate
net operating profit after tax (NOPAT) Calculate total invested
capital (TC) Determine a cost of capital (WACC) Calculate EVA =
NOPAT WACC% * (TC) It is a financial performance method to
calculate the true economic profit of a company 17
Used for: setting organizational goals, performance management,
determining bonuses, communication with shareholders &
investors, motivation of managers, capital budgeting, corporate
valuation, analyzing equity securities (the non-debt securities of
a corporation representing an ownership interest) Links employee
performance with profits It is the net operating profit minus an
appropriate charge for the opportunity cost of all capital invested
in an enterprise An estimate of true economic profit Amount by
which earnings exceed or fall short of the required minimum rate of
return that shareholders could get by investing in other securities
of comparable risk Calculated by combining 3 factors: net operating
profit after taxes, capital & cost of capital Continuous
improvement in EVA brings continuous increase in shareholders
wealth since a sustained increase in EVA brings increase in market
value of the company Incorporates 2 principles of finance into
management decision making Primary objective of any company is to
maximize the wealth of its shareholders The value of a company
depends on the extent to which investors expect future profits to
exceed or fall short of the cost of capital NIIT, TCS & Godrej
have implemented EVA in India Across the world, Seimens, Sony,
Whirlpool, Johnson & Johnson, Cadbury, Bausch & Lomb have
implemented EVA New concept for productivity enhancement, investors
confidence & employee motivation Steps for implementing
EVAMeasuring of EVA concept defined & explaining throughout the
company Managing through training programmes oriented to educate
the managers how they would earn in direct proportion to the wealth
that the company would make Motivation of employee benefits /
rewards through performance linked remuneration scheme Preparing
mindset of employees in the long-run, to understand the impact of
EVA on their personal remuneration INCENTIVE PLANS: Five Types:
Merit Pay Gainsharing ProfitSharing Stock Options ESOPs Merit Pay:
An incentive plan implemented on an institutional wide basis to
give all employees an equal opportunity for consideration,
regardless of funding source. The merit increase program is
implemented when funds 18
are designated for that purpose by the institution's
administration, dependent upon the availability of funds and other
constraints. . Advantages Allows the employer to differentiate pay
given to high performers. Allows a differentiation between
individual and company performance. Allows the employer to
satisfactorily reward an employee for accomplishing a task that
might not be repeated (such as implementation of new systems).
Gainsharing: A technique that compensates improvements in the
company's productivity. How does Gainsharing work? A Company shares
productivity gains with the workforce. Workers voluntarily
participate in management to accept responsibility for major
reforms. This type of pay is based on factors directly under a
workers control (i.e., productivity or costs). Gains are measured
and distributions are made frequently through a predetermined
formula. Because this pay is only implemented when gains are
achieved, gainsharing plans do not adversely affect company costs.
What are the 'Gains' that are measured?
workers
based
on
Increases in production with equal or less effort. Equal levels
of production with less effort.
What are examples of Gainsharing formulas?
Calculate gain in hours: The actual hours worked minus the
expected hours (for the given level of output) equals the gain in
hours.
Advantages Disadvantages Helps companies achieve Adherence to
the FLSA sustained increases in requires employers to productivity.
recalculate each worker's Employees become more "regular rate" of
pay. To involved the productivity gains overcome this limitation,
made by the employer. employers may restrict this Employees can
share in the type of compensation to benefits of employee exempt
employees. sponsored improvements. The formulas and program
Enhances commitment to may be difficult to organizational goals.
understand. Leads to improvements in Requires a shift to a more
other measures of company team oriented management performance,
including: style. teamwork, product quality, lower rates of
absenteeism, defects, and "downtime." 19
When does Gainsharing work best? Works best when company
performance levels can be easily quantified. Employee involvement
significantly enhances the effectiveness of incentive pay. When
used simultaneously, productivity gains from combining these
techniques can exceed gains achieved separately. What is the best
way to implement Gainsharing? Meet with executives to develop a
clear understanding of Gainsharing. Develop various formulas and
models to be used in predicting future gains and the costs
associated with sharing those gains. Prepare rules, presentation
materials, and dissemination of policy. Retrain supervisors and
administrators. Teams of employees are selected by peers to develop
cost-saving measures. Through their personal knowledge about their
jobs, employees are able to reduce waste and increase efficiency.
Profit Sharing: An incentive based compensation program to award
employees a percentage of the company's profits. How does Profit
sharing work? The company contributes a portion of its pre-tax
profits to a pool that will be distributed among eligible
employees. The amount distributed to each employee may be weighted
by the employee's base salary so that employees with higher base
salaries receive a slightly higher amount of the shared pool of
profits. Generally this is done on an annual basis. Advantages
Disadvantages Brings groups of employees to The pay for each
employee work together toward a moves up or down together (no
common goal (the individual differences for merit success/benefit
of the or performance). company). Focuses only on the goal of Helps
employees focus on profitability (which may be at profitability.
the expense of quality). The costs of implementing the For smaller
companies, these plan rise and fall with the plans may result in
drastic company's revenues. swings in earnings for Enhances
commitment to employees which the organizational goals. employees
may find difficult to manage their personal finances. Adherence to
the FLSA requires employers to recalculate each worker's "regular
rate" of pay. To overcome this limitation, employers may restrict
this type of compensation to exempt employees.
20
When does Profit sharing work best? When company earnings are
relatively stable (or steadily increasing). What is the best way to
implement Profit sharing? Meet with executives to develop a clear
understanding of profit sharing. Develop various formulas and
models to be used in predicting future gains and the costs
associated with sharing those gains. Prepare rules. Stock Options:
The right to purchase stock at a given price at some time in the
future. Stock Options come in two types: 1. Incentive stock options
(ISOs) in which the employee is able to defer taxation until the
shares bought with the option are sold. The company does not
receive a tax deduction for this type of option. 2. Nonqualified
stock options (NSOs) in which the employee must pay infome tax on
the 'spread' between the value of the stock and the amount paid for
the option. The company may receive a tax deduction on the
'spread'. How do Stock options work? An option is created that
specifies that the owner of the option may 'exercise' the 'right'
to purchase a companys stock at a certain price (the 'grant' price)
by a certain (expiration) date in the future. Usually the price of
the option (the 'grant' price) is set to the market price of the
stock at the time the option was sold. If the underlying stock
increases in value, the option becomes more valuable. If the
underlying stock decreases below the 'grant' price or stays the
same in value as the 'grant' price, then the option becomes
worthless. They provide employees the right, but not the
obligation, to purchase shares of their employer's stock at a
certain price for a certain period of time. Options are usually
granted at the current market price of the stock and last for up to
10 years. To encourage employees to stick around and help the
company grow, options typically carry a four to five year vesting
period, but each company sets its own parameters. Advantages
Disadvantages o Allows a company to o In a down market, share
ownership with because they quickly the employees. become valueless
o Used to align the o Dilution of ownership interests of the o
Overstatement of employees with those operating income of the
company. Nonqualified Stock Options Grants the option to buy stock
at a fixed price for a fixed exercise period; gains from grant to
exercise taxed at income-tax rates Advantages Disadvantages o
Aligns executive and o Dilutes EPS shareholder interests. o
Executive investment 21
o o
Company receives tax deduction. No charge to earnings.
o
is required May incent short-term stock-price manipulation
Restricted Stock Outright grant of shares to executives with
restrictions to sale, transfer, or pledging; shares forfeited if
executive terminates employment; value of shares as restrictions
lapse taxed as ordinary income Advantages Disadvantages o Aligns
executive and o Immediate dilution of shareholder interests. EPS
for total shares o No executive granted. investment required. o
Fair-market value o If stock appreciates charged to earnings after
grant, company's over restriction period. tax deduction exceeds
fixed charge to earnings. Performance shares/units Grants
contingent shares of stock or a fixed cash value at beginning of
performance period; executive earns a portion of grant as
performance goals are hit Advantages Disadvantages o Aligns
executives and o Charge to earnings, shareholders if stock marked
to market. is used. o Difficulty in setting o Performance oriented.
performance targets. o No executive investment required. o Company
receives tax deduction at payout. When do Stock options work best?
-Appropriate for small companies where future growth is expected.
-For publicly owned companies who want to offer some degree of
company ownership to employees. What are important considerations
when implementing Stock Options? -How much stock a company be
willing to sell. -Who will receive the options. -How many options
are available to be sold in the future. -Is this a permanent part
of the benefit plan or just an incentive.
22
ESOPs Employee Stock Ownership Plan (ESOP): An ESOP is a defined
contribution employee benefit plan that allows employees to become
owners of stock in the company they work for. It is an equity based
deferred compensation plan. Several features make ESOPs unique as
compared to other employee benefit plans. First, only an ESOP is
required by law to invest primarily in the securities of the
sponsoring employer. Second, an ESOP is unique among qualified
employee benefit plans in its ability to borrow money. As a result,
"leveraged ESOPs" may be used as a technique of corporate finance.
ESOPs An opportunity to buy stock at a set price some time in
future for a stated period Stock option is the right or privilege
to buy stock under an offer valid for a stated period A form of
variable pay compensation package Objectives of ESOPs Instrument
for attracting critical skills / highly valued or scarce skills
Inculcates employee feeling of ownership and commitment Creates
additional wealth for employees Supplement retirement / social
security benefits For employee retention particularly for groups
apprehended of high turnover Helps introduce a performance
management system without incurring full cash out flow / lessening
possible individual differences in the immediate cash bonus
Enforces corporate governance Infosys, Wipro, Maruti Udyog Limited,
GE, Godrej, P & G, Zee Network, Castrol etc have introduced
ESOPs Features of ESOPs It is a qualified, defined contribution
employee benefit plan that invests primarily in the stock of the
employer A company has to create a trust fund for employees and
funds it by contributions of stock, cash or buy stock or cash to
pay back the ESOPs loan and to buy back stock in order to set-up a
ESOP system Shares held by ESOP trust are distributed to the
employees through an employee option scheme Return on an ESOP
portfolio is linked to company performance since investment is
through employers securities All employees except part-time
directors are eligible to ESOPs of the company The terms, price
& offer of ESOPs is done by compensation committee of the board
of directors Options granted to employee are not transferable to
any other person ESOP trust provides a warehouse for sponsoring
companys shares which can be sold or transferred to employees in
future 23
Reservation up to 5% can be made by the issuer of the company
for employees of his company or promoters of the company 3 stages:
Grant of option (enable employee to purchase a certain number of
shares of the company stock at a determined price, usually within a
specified period of time) Vesting (employee gets right to apply for
the shares) Exercise of option (on payment of exercise price,
employee is conferred the shares of the company) There is a minimum
period of one year between grant of options and vesting of options
& company shall have the freedom to specify lock in period
Typically, lock-in period of 3-5 years with the provision that if
employee separates from the service of the company (except in the
case of death / medical incapacity), the shares would be forfeited
& reverted to the trust Shares are not physically transferred
to employees at this stage Once the shares are transferred in
favour of the employee, only then the latter may decide to sell
them in the market (this sale will attract capital gains tax)
During the lock-in period, the shares registered in the name of the
employee would be kept in the custody of the trust Types of ESOPs
One-off, uniform An offer plan where the company may decide to
include non-performers, trainees, short-service staff, temps A
one-time allotment for an equal number of shares, options or
warrants to all at the market value SEBI guidelines allow allotment
of options below the market price for shares, subject to the
differential being accounted in the books of the company One-off,
differential / discretionary Also a one-off scheme where company
may differentiate allotments by grades, seniority or market value
of special skills Factors like achievements, potential, loyalty,
hard work & contribution to corporate performance if
considered, then the discretionary element will go up considerably
Ongoing schemes Use a combination of uniform, differential &
discretionary allotments dynamically. May be warrants, shares or
options that can be issued as sign-on bonus on confirmation /
promotion / superannuating / recognition of outstanding
contribution Given to some or all individuals Have a vesting
schedule Are structured to enable flexibility Proxy: stock
appreciation rights / phantom shares Notional units apportioned to
employees 24
Are productivity / contribution linked incentive programmes
rather than stock option plans An employee is allotted notional
units / shares of the company based on certain criteria at a set
price Employee is required to exercise his option within a given
period (say 2 years) when the share price is high & will be
eligible to draw the differential or the whole in cash on deduction
of tax Provision is made to enable employees to decline the shares
& opt for the cash differential between the cost of exercise
& the market price It would have the effect of a stock
appreciation right / phantom share Some definitions Phantom stock a
bonus that rewards employees based on the value of the companys
stock & the dividend performance of the stock Discount stock
option stock option with an exercise price which is less than the
fair market value on the sale of the grant Indexed stock option the
exercise price is equal to the fair market value at grant, but the
price adjusts upward or downward depending on an index (in relation
to the market / industry / peer group performance / any other
measure) Performance accelerated stock option has a fair market
value exercise price & a service based vesting schedule (longer
than traditional options which are generally for 10 years), but
which becomes exercisable at an earlier date in case specified
performance goals are achieved Performance contingent stock has a
fair market value price, which becomes exercisable only when
performance goals are achieved. It lapses in case the set goals are
not achieved Purchased stock option down payment required to be
made (% of the market price) before the option may be exercised
Reload/restoration stock option stock option automatically granted
upon the exercise of a previously granted stock option to the
extent that the optionee uses shares rather than cash to pay the
purchase price of the original option (the exercise price of the
reload option is the fair market value on the date of the grant
& reload option expires on the same date as the original option
Variable - priced stock option with an exercise price that
fluctuates upward or downward in relation to stock price
performance (yo-yo stock option or indexed stock option) Premium
stock option exercise price greater than the fair market value on
the date of the grant How does ESOP work? The ESOP operates through
a trust, setup by the company that accepts tax deductible
contributions from the company to purchase company stock.
25
The contributions made by the company are distributed to
individual employee accounts within the trust. The amount of stock
each individual receives may vary according to pre-established
formulas based on salary, service, or position. The employees may
cash out after vesting in the program or when they leave the
company. The amount they may cash out may depend on the vesting
requirements. When an ESOP employee who has at least ten years of
participation in the ESOP reaches age 55, he or she must be given
the option of diversifying his/her ESOP account up to 25% of the
value. This option continues until age sixty, at which time the
employee has a one-time option to diversify up to 50% of his/her
account. This requirement is applicable to ESOP shares allocated to
employee's accounts after December 31, 1986. Employees receive the
vested portion of their accounts at either termination, disability,
death, or retirement. These distributions may be made in a lump sum
or in installments over a period of years. If employees become
disabled or die, they or their beneficiaries receive the vested
portion of their ESOP accounts right away.
Advantages Disadvantages Capital Appreciation. Dilution. If the
ESOP is used Companies sell some or all of to finance the companys
their equity to employees and growth, the cash flow benefits by
doing so convert corporate must be weighed against the and personal
taxes into rate of dilution. tax-free capital appreciation.
Fiduciary Liability. The plan This allows the owner to sell
committee members who 100% of his or her company, administer the
plan are get money out tax-free and deemed to be fiduciaries, and
still maintain control of the can be held liable if they company.
knowingly participate in Incentive Based Retirement. improper
transactions. Provides a cost-effective plan Liquidity. If the
value of the to motivate employees. After stock appreciates all,
who works harder, owners substantially, the ESOP or employees?
and/or the company may not Tax Advantages. Enables tax have
sufficient funds to advantaged purchasing of repurchase stock, upon
stock of a retiring company employees retirement. owner. With this
purpose, a Stock Performance. If the company owner may sell their
value of the company does not shares to the ESOP and incur
increase, the employees may no taxable gain on the sale. A feel
that the ESOP is less company owner can sell all or attractive than
a profit sharing some of the company to the plan. In an extreme
case, if the employees cost free. Owners company fails, the
employees who sell 30% or more of their will lose their benefits to
the 26
company to an ESOP are allowed to "roll-over" the proceeds into
other securities and defer taxation on the gain. Company reduces
it's tax liability. A company can reduce its corporate income taxes
and increase its cash flow and net worth by simply issuing treasury
stock or newly issued stock to its ESOP.
extent that the ESOP is not diversified in other investments
What is the best way to implement ESOP? 1. Determine how you
want to use the ESOP. Will it be used as an employee benefit plan?
Or, as an incentive program? 2. Conduct a feasibility study to
determine the value of the companys stock and impact of the
contributions that must be made to the trust. 3. An ESOP requires
different accounting procedures and a different method of
allocating stocks and other investments among the employees than
other types of plans. For this reason the plan should be designed
by an ESOP specialist in order to avoid IRS difficulties. What are
the alternatives to ESOP? 1. Employee stock options. Profit
Sharing. An ESOP differs from a profit sharing plan in that an ESOP
is required to invest primarily in employer securities, while a
profit sharing plan is usually prohibited from investing primarily
in employer securities. LAWS & REGULATIONS RELATED TO
COMPENSATION PAYMENT OF WAGES ACT, 1936 An Act to regulate the
payment of wages to certain classes of employed persons MINIMUM
WAGES ACT, 1948 An Act to provide for fixing minimum rates of wages
in certain employments EQUAL REMUNERATION ACT, 1976 An Act to
provide for the payment of equal remuneration to men and women
workers and for the prevention of discrimination, on the ground of
sex, against women in the matter of employment and for matters
connected therewith or incidental thereto. 27
PAYMENT OF BONUS ACT, 1965 Act to provide for the payment of
bonus to persons employed in certain establishments on the basis of
profits or on the basis of production or productivity and for
matters connected therewith. EMPLOYEES' STATE INSURANCE ACT, 1948
An Act to provide for certain benefits to employees in case of
sickness, maternity and employment injury and to make provision for
certain other matters in relation thereto EMPLOYEES' PROVIDENT
FUNDS AND MISC. PROVISIONS ACT, 1952 An Act to provide for the
institution of provident funds 2*[3*[, family pension fund and
deposit-linked insurance fund]] for employees in factories and
other establishments THE PAYMENT OF GRATUITY ACT, 1972 An Act to
provide for a Scheme for the payment of gratuity to employees
engaged in factories, mines, oilfields, plantations, ports, railway
companies, shops or other establishments and for matters connected
therewith or incidental thereto THE WORKMEN'S COMPENSATION ACT,
1923 An Act to provide for the payment by certain classes of
employers to their workmen of compensation for injury by accident
PROBLEMS & ISSUES Whether extrinsic rewards such as
performance-related pay actually motivate employees to better
performance is a matter of controversy. It has been claimed that
monetary rewards usually have a limited time-span in regard to
their motivating effect. Therefore extrinsic rewards such as
performance pay, even if they can exert a continuing impact on
performance, should
be consistent with overall management objectives, so that
performance pay may not be consistent with, for example, a purely
cost reduction strategy & only be used to reinforce a
motivational system in which intrinsic (non monetary) rewards
exist, such as reorganization of work processes, training, employee
involvement/consultation in decision-making, two-way communication,
opportunities to contribute ideas, career development plans and
goal setting.
Some of the reasons for the failure of performance-related pay
and some of the problems and issues facing employers flow from a
variety of circumstances such as the following: i. Inadequate
criteria to measure performance, or criteria which are not easily
understood, communicated and accepted. Performance pay should
therefore be negotiated.
28
ii.
Inappropriate performance appraisal systems in that the
objectives of the appraisal system (e.g. where it is intended to
identify training needs or suitability for promotion) do not match
the objectives of the reward system. The absence of regular
feedback on performance. The reward system is not designed to meet
the objectives sought to be achieved. There could be a variety of
objectives e.g. to satisfy distributive justice, attract and retain
capable staff, match particular levels of pay in the labour market,
change organizational culture (e.g. towards greater customer
satisfaction) or to reinforce it. The absence of a right mix of
extrinsic and intrinsic rewards. The lack of an appropriate quantum
of pay which should be subject to performance criteria. This occurs
when the amount which depends on performance is too small, or it is
too large and therefore the amount placed at risk (when performance
is poor) is not acceptable to employees. The absence of periodic
evaluation of the scheme. Non-recognition of the fact that
performance, especially profit, is sometimes (even often) dependent
on factors outside the control of employees e.g. management
decisions, exchange rates, recessions.
iii. iv.
v. vi.
vii. viii.
There are many arguments in favour of performance-related pay
which are theoretically attractive. However, it is not easy to find
evidence which unequivocally supports or disproves these views,
because of the scarcity of empirical evidence or because the
introduction of the scheme has been faulty. Governments can
sometimes facilitate the introduction of performance-based pay. In
Britain for instance, the Finance Act of 1987 introduced tax relief
for approved schemes to encourage their adoption and proliferation.
Two benefits at the macro level have been claimed for performance
pay. The first relates to employment. If increases in basic pay are
transferred to a profit-related scheme (e.g. 10% of basic pay), the
employer may be more inclined to hire new employees as his wage
cost is less than otherwise. If the percentage of profit to be
shared remains fixed, additions to the workforce do not cost the
employer more in terms of the profit-related pay. On the other
hand, new recruitment would reduce the quantum existing employees
will receive unless profits increase, and consequently
dissatisfaction among employees could set in. The second argument
is that if basic pay is reduced as a percentage of total earnings,
increased earnings will not result in inflationary tendencies as
such increases are the result of increased profits/productivity.
The benefits to management and employees are:
where performance/profits increase, higher pay is an incentive
to employees 29
where profits reduce, the reduction in the performance-related
pay can cushion employees against redundancies employee
identification with the success of the business is enhanced
variations in pay lead to employees becoming more familiar with the
fortunes (or misfortunes) of the business. This would depend on the
information-sharing practices of the management.
Several criticisms of a general nature (apart from those
directed at particular types of schemes) have been made against
performance-related pay. Among them are the following: i. ii. iii.
where the performance earnings fall employees are less inclined to
accept reductions in their guaranteed pay positive employment
effects could be negated due to opposition from employees to
recruitment as it would dilute their earnings since
performance/profits depend on a variety of factors beyond the
control of employees, it is not possible to link pay to the
performance of employees. If it is linked to the overall
performance of the enterprise, then management decisions should
logically be subject to scrutiny by employees. it is difficult to
determine whether the amounts paid out under schemes are more than
matched by performance gains.
iv.
Even though the evidence is not always clear whether
profit-sharing, for instance, raises productivity levels, the
positive link between profit-sharing and productivity is clearer in
enterprises with employee participation arrangements. Where the
extra payments replace a fixed wage component and is not an
additional component of pay, there is a greater likelihood that the
extra pay is matched by performance increases. In the case of group
incentives payments are never proportionate to individual
performance, as poor performers ("free riders") benefit from the
efforts of others. WAGE THEORIES & LABOUR MARKET ECONOMIC
THEORIES CLASSICAL SOCIAL WAGE THEORIES A. Subsistence Theory
Propounded by David Ricardo, 1817 Also known as the "Iron Law of
Wages Was an alleged law of economics that asserted that real wages
in the long run would tend to the value needed to keep the workers'
population constant Ricardo drew a distinction between a natural
price and a market price. For Ricardo, the natural price of labor
was the cost of maintaining the laborer. However, Ricardo believed
that the market price of labour or the actual wages paid could
exceed subsistence level indefinitely due to countervailing
economic tendencies Ricardo believed that the market price of labor
could long exceed the subsistence or natural wage 30
He also claimed that the natural wage was not what was needed to
physically sustain the laborer, but depended on "habits and customs
The labourers are paid to enable them to subsist & perpetuate
the race without increase or diminution The theory maintains that
wages cluster around the bare subsistence level of workers. A wage
rate much above the subsistence level causes an increase in the
number of workers; competition will then lead to a depression of
wages back towards the cost of subsistence. Wages that are below
subsistence reduce the size of the working population; in that case
competition will raise wages, but only up to the subsistence level
again. * Subsistence means minimum resources required for existence
* Diminution means change toward something smaller or lower B. Wage
Fund Theory 1 Developed by Adam Smith (18Century) 2 The wage-fund
theory is that wages are advanced out of a fixed fund of capital,
from which an excess withdrawal, either through legislation or
through union pressure, will ultimately reduce the amount available
for other workers. 3 Any increase in wages would also have to be
taken out of profits, and their reduction would cause a decline in
savings, which provide the capital from which the wage fund is
derived. 4 Basic assumption wages are paid out of a pre-determined
fund of wealth which lay surplus with wealthy persons as a result
of savings. This fund could be utilized for employing labourers for
work. If the fund was large, the wages would be high; if it was
small, the wages would be reduced to the subsistence level The
demand for labour & the wages that could be paid them were
determined by the size of the fund C Residual Claimant Theory -
Propounded by Francis Walker in 19th Century - There are 4 factors
of any business activity: Land, Labour, Capital, Entrepreneurship
Wages represent the amount of value created in the production which
remains after payment has been made for all these factors of
production, thus implying that The labour is the residual claimant
- After all the factors of production have received their
compensation for their contribution to the process, only then the
labourers wages come to the fore Theory does not explain how trade
unions are able to increase the wages No role of labourers in
productivity D Marxian Theory - In the surplus-value theory as
propounded by Karl Marx, the value produced by the worker in excess
of what is paid in wages is called surplus value - The surplus
value, exacted from the worker, constitutes the capitalist's profit
- According to this theory, labour was an article of commerce could
be 31
purchased on payment of subsistence price The price of any
product was determined by the labour time needed for producing it
The labourer was not paid in proportion to the time spent on work,
but much less The surplus went over, to be utilized for paying
other expenses JUSTIFICATION THEORIES A. Marginal Productivity
Theory - Developed by Philips Wicksteed & John Bates The wages
are based upon an entrepreneurs estimate of the value that will
probably be produced by the last of marginal worker It assumes that
the wages depend on the demand for, and supply of labour Workers
are paid what they are economically worth The employer has a larger
share in profit as has not to pay for the non-marginal workers As
long as each additional worker contributes more to the total value
than the cost in wages, it pays the employer to continue hiring
When this process becomes non-viable & uneconomic, the employer
may resort to superior technology - This theory maintains that
employers will only pay a wage that is, at most, equal to the
amount of extra value added to the total product by one additional
worker B. Bargaining Theory - Propounded by John Davidson - Wages
are determined by the relative bargaining power of the workers /
trade unions & of employers - When a trade union is involved,
basic wages, fringe benefits, job differentials, and individual
differences tend to be determined by the relative strength of the
organization & the trade union - The bargaining theory modifies
the marginal-productivity theory by: Taking into consideration
other factors (e.g., laws and social and political changes) that
might affect the determination of wage levels Acknowledging that
certain basic assumptions (equal bargaining power of employer and
employee, free competition between the two, and mobility of labor)
that characterize the marginal-productivity theory do not hold in
our present economic system C. Supply & Demand Theory -
Inter-relation between wages & employment - Unemployment were
to disappear if workers were to accept a voluntary cut in wages
have wage flexibility for promoting employment at a time of
depression. - These wage cuts would bring down costs and thereby
fall in price - This lowering in prices would cause additional
demand which will increase production - This will increase
employment of workers D. Competitive Theory - Employers compete
amongst themselves by offering a higher pay 32
/ wage to attract employees while employees compete with another
for jobs by offering their services for a lower wage - Competition
then, is essentially a disequilibrium process by which excess
demand and excess supply cause changes in wages Behavioral Theories
A. Employees acceptance Level - This theory takes into
consideration, the factors which may induce an employee to stay on
with the company Size & reputation of the company Power of the
union Wages and benefits that the employee receives in proportion
to the contribution made by him / her B. Internal Wage Structure -
Wage Structure affected by Social norms / traditions / customs
prevalent in the organization Psychological pressures on the
management Prestige attached to certain jobs in terms of social
status The need to maintain internal consistency in wages at all
levels The ratio of maximum & minimum wage differentials Norms
of span of control Demand for specialized labour C. Wage &
Motivators - Purchasing power provided by monitory income helps
workers to take care of their basic needs: Food / Clothing /
Shelter / Transportation / Insurance / Pension Plans / Education /
Other physical maintenance & security factors - Monitory income
includes: Wages / Merit increases / performance based bonuses
EVOLUTION OF MODERN-DAY WORKFORCE Advent of the Labour Force During
the period of foreign rule, Britishers introduced industrialization
and thereby heralded the advent of labour sector in this country.
With the emergence of native industrialists the labour sector
expanded. The pace of industrialization and the expansion of labour
sector were accelerated by the first and second world wars. In the
early years the workers organized to obtain wages to meet limited
needs for livelihood and convenience to work decently. Labour
struggle became a part of national movement. The concepts of
freedom, democracy, secularism and socialism, were indoctrinated in
the labour movement, thanks to agitations for rights of workers.
The trade union leaders of yesteryears played a glorious role in
this respect. We are still striving to ensure social security
measures envisaged in the directive principles of the Indian
Constitution such as right to work, living wages, security in work
place etc. Today the economy of the nation itself is facing grave
crisis due to the impact of globalization, and the labour sector is
in the dark shadows of 33
economic and social problems. The threats faced by the economy
of the nation, industry, agriculture and thereby the labour sector
are due to the impact of the global pressures and hence beyond our
control. Yet we are compelled to defend ourselves to protect our
economic and social security Consequent on the grave crisis in the
Indian economy, significant reforms based on liberalization,
globalization was enforced from 1991. It was these economic reforms
that dictated the industrial policy from then on. Only after a
couple of years of reforms that negative effects on other sectors
of polity came to be felt, the most affected being the Labour Need
of the Hour Ensuring equity as well as accelerating the rate of
growth of economy in the labour market is the need of the hour It
is necessary to ensure significant improvements in the quality of
labour, productivity, skill development and working conditions, and
to provide welfare and social security measures particularly, to
those in the unorganized sector It is also necessary to ensure that
all adult persons looking for work are employed at levels of
productivity and income, which are necessary to afford them a
decent life. A significant proportion of workers presently earn
below the subsistence wages Another unfortunate facet of labour
markets is the persistence of child labour which must be eradicated
in the shortest possible time Background Modern day professions as
we know them had their origin in the post-industrial age after
World War II when most Western nations saw a long spell of growth
This era also saw the emergence of modern day consumerism. To cater
to the emerging needs of the market, huge corporations built
gigantic factories to manufacture products and serve the needs of
consumers They also started employing thousands of people to
manufacture, service and market the products Sometime during this
period (in 1956), William H Whyte wrote his much acclaimed book
titled the Organization Mana term which caught the fancy of an
entire generation of working professionals. For Whyte Organization
Men are People who only work for the Organization. They are the
ones of our middleclass who have left home, spiritually as well as
physically, to take the vows of organization life, and it is they
who are the mind and soul of our great self-perpetuating
institutions For nearly half century after the book appeared,
Organization Man typified the working class. In most parts of the
world, huge corporationsprivate, public and
government-ownedemployed hundreds of thousands of Organization Men
In the US, Fortune 500 companies created millions of jobs.
Similarly, UK, Europe, the Eastern bloc, and India saw the
emergence of huge government owned corporations and Public Sector
Undertakings (PSUs) that employed millions In many parts of the
world, government service was the career choice for a generation of
the best and the brightest. In India, joining the 34
Indian Administrative Service (IAS) or Police Service (IPS) was
the dream In the US, President Kennedys "send a man to the moon"
project captured the imagination of a whole generation of
youngsters who either wanted to become rocket scientists or
astronauts for NASA A whole generation of the best and brightest
from top universities competed to give their life and souls, and
dedicate their professional lives to mammoth corporations by
joining the burgeoning ranks of Organization Men. In return, they
were assured of a steady paycheck, raises, promotions and a golden
watch at retirement, with a guaranteed pension to boot Educated
professionals were not the only ones welcomed by these
organizations There was a need for everyonefrom the mailroom clerk
and janitor to shop floor workers, supervisors and managers; and
everyone else in between One common aspect binding all employees
was their unrelenting loyalty to the organization. There was very
little individualism and entrepreneurship shown (or expected) by
employees, and most of the decision-making took place in ivory
towers at head offices The organizations asked for, and got the
unwavering following of its organization men; in return, it
guaranteed employment, almost taking on a patriarchal role for
families of organization men Transition There is little debate over
the fact that we are experiencing a major shift in the job market
worldwide Changes in the marketplace are leading to a fundamental
shift in careers and professions across the board Perhaps the most
important shift in the paradigm is the move from Organization Man
to Free Agents or Gold Collar Workers Individuals will not remain
loyal to one single organization, just as most organizations have
given up on guaranteeing lifetime employment New entrants to the
job-market, and even those who have been working in the corporate
world for a while are starting to realize that we cannot hope to
become, or remain, Organization Men The New Generation This
workforce contains the now generation, me generation, new breed,
and new X generation These generations have been variously
described as having lower overall job satisfaction, less desire to
lead (move up the organizational hierarchy) and to defer to
authority; believe that they are entitled to a good job; have a
strong a desire to control their own destiny; have a low
absenteeism threshold They have also been described as having a
lower respect for authority, and a greater desire for
self-expression, personal growth, and self-fulfillment This group
also tends to be more educated than their predecessors, in most
cases, they are more educated than their supervisors 35
Impatience and self-confidence define today's educated young
worker In older times, people used to do anything to get a job -
Today everyone thinks they're entitled to a job In the old days,
such attitudes were unimaginable; they would have been
self-defeating Companies are no longer in the driver's seat -
Employees are in control now Labor Market Discrimination
What is Discrimination? The valuation in the market place of
personal characteristics of the worker that are unrelated to worker
productivity. o These personal characteristics may be sex, race,
age, national origin, religion, education or sexual preference
Labor market discrimination may take the form of different wage
rates for equally productive workers with different personal
characteristics Labor market discrimination may also take the form
of exclusion from jobs on the grounds of social class, union
membership, or political beliefs Labor Market Discrimination
Discrimination is a cause of labour market failure and a source of
inequity in the distribution of income and wealth and it is usually
subject to government intervention e.g. through regulation and
legislation Discriminatory treatment of minority groups leads to
lower wages and reduced employment opportunities, including less
training and fewer promotions. The result is that groups subject to
discrimination earn less than they would and suffer a fall in
relative living standards Why does discrimination occur in the
labour market? The 'Taste' Model - Discrimination arises here
because employers and workers have distaste for working with people
from different ethnic backgrounds or final customers dislike buying
goods from salespeople from different races i.e. people prefer to
associate with others from their own group. They are willing to pay
a price to avoid contact with other groups. With reference to race,
this is equivalent to racial prejudice Employer ignorance
Discrimination also arises because employers are unable to directly
observe the productive ability of individuals and therefore easily
observable characteristics such as gender or race may be used as
proxies the employer through ignorance or prejudice assumes that
certain groups of workers are less productive than others and is
therefore less willing to employ them, or pay them a wage or salary
that fairly reflects their productivity, experience and
applicability for a particular job Occupational crowding effects
Females and minorities may be crowded into lower paying
occupations. There is little doubt that a permanent gap exists
between average pay rates for females and males in the labour
markets of UK, US, Africa, Europe & Asia Quality in Labour
Market Towards Productive Employment 36
Country like India has tremendous labor cost advantage as far as
daily or monthly wage rates are concerned. But there are
limitations due to poor quality of training and skills,
non-professional approach, low productivity and too many labor
laws. The labor market is deregulated & there is increased
mobility of labor in global markets Many other low cost countries
like china, Mexico, Turkey, SAARC region neighbors, some north
African and Latin American countries are moving fast on learning
curve and will offer tough competition to Indian exporters in low
cost labor advantage The real labor cost will rise in countries
like India erasing much of low cost advantage of labor Labour
market demands are changing with greater emphasis on the quality of
jobs Labour market reforms are necessary to cope with the
accelerating economic and social restructuring associated with
globalization, technological processes and the development of an
inclusive knowledge and information society and economy In an era
of globalization where capital, technology, high skills and high
productivity play a major role in labour markets In India, like in
many other developing countries, the growth of labour force is
accelerating and will remain high for quite sometime It needs rapid
economic growth with effective and efficient utilization of labour
by upgrading its skills to ensure development and employment
generation. Intervention is required in labour markets to promote
employment and its quality. Quality in work including training,
career prospects and work organization makes a valuable
contribution towards increasing employment and productivity
Improvements in the quality of work may increase the efficiency of
production processes by allowing employers to exploit fully the
potential of new technologies They are further likely to increase
employees motivation and job satisfaction Upgrading the quality of
labour force by pursuing suitable education and skill development
policies Low quality of jobs and low productivity is directly
attributable to low level of skills. The latter poses a serious
challenge to integration of the labour force in world economy There
is overwhelming evidence that whereas educated and skilled workers
are generally able to derive some benefits of new opportunities as
a result of globalization, it is the uneducated and unskilled
workers on whom the burden of re-structuring falls Designing
appropriate training systems is, therefore, an important means to
deal with labour market instabilities like under-employment, skill
mismatch and redundancy Higher productivity of labour would, apart
from dignity of labour, improve the living standards of workers and
also help the industry in facing international competition An
increase in overall productivity and skill up-gradation will lead
to 37
progressive absorption of large number of workers from informal
or unorganized sector in the formal or organized sector and ensure
rapid economic growth Quality of labour force alone determines
their employability abroad or in institutions of foreign origin
including multinational organization Manpower development to
provide rising labour force with skills and training according to
the emerging demand pattern is essential to eliminate the mismatch
between the supply of and demand for labour Reward Management in
TNCs (Transnational Corporations) Transnational Corporations
Transnational Corporation means a for-profit enterprise marked by
two basic characteristics: It engages in enough business activities
-- including sales, distribution, extraction, manufacturing, and
research and development -- outside the country of origin so that
it is dependent financially on operations in two or more countries
Its management decisions are made based on regional or global
alternatives In an era of declining constraints on their mobility
and the attraction of cheaper wages in less-industrialized nations
eager to draw foreign investment, TNCs are eliminating jobs in
their home countries and shifting production abroad In
less-industrialized regions, the lure for TNCs of fewer costs and
regulations offers little promise to workers of decent working
conditions, sufficient pay, or job security. Tax breaks and
subsidies governments use as incentives are no guarantee that the
TNCs will not move on after the benefits have expired, and as cost
advantages now found in Singapore appear in, say, Bangladesh, the
countries currently experiencing an influx of investment may
eventually find themselves in the same position as that of the US
and other industrialized nations today. TNCs are corporations that
operate in more than one country. Usually, headquarters are in one
or more nations and production or services are in another have
become some of the most powerful economic and political entities in
the world today. Such companies have a geocentric orientation and
attempt to be responsive to both national markets, while
simultaneously seeking global coordination The number of
transnational corporations in the world has jumped from 7,000 in
1970 to 40,000 in 1995 What is the difference between Multi
National Corporation and Trans National Corporation? MNCs operate
in several different countries while transnational implies "just
across the border" as in the US and Canada. Obviously, both operate
internationally A MNC has a centralized headquarters & is a
corporation with extensive ties in international operations in more
than one foreign country. Examples are Coke, Pepsi, General
Electric, Exxon, Wal-Mart, Mitsubishi, Diamler Chrysler 38
A transnational company has no "head office" and moves whatever
base of operations it has fluidly between its national offices. It
is a MNC that operates worldwide without being identified with a
national home base i.e. it is said to operate on a borderless
basis. Examples are Daewoo, Saint Gobain, Daimler-Benz, Sony,
Samsung Group, Shell Oil etc Reward Management - The type and
amount of compensation necessary to attract technically and
culturally qualified international managers and technical
professionals to the three nationals or country categories involved
international human resource management activities from which
employees are selected whether the people are: PCNs (parent country
nationals) TCNs (third country nationals) or HCNs (host country
nationals) - HR managers focus on their strategic objectives to
develop a comprehensive compensation plan, in terms of considering
base pay, short and long-term incentives, benefits and growth
opportunities - The objective of this kind of strategy is to ensure
that both TNC/MNCs long and short-term objectives coexist in the
compensation system without overlap, which would duplicate a single
pay plan for the same objectives. - The purpose of the planning is
also designed to ensure that the compensation system attracts and
retains the desired employees and that it motivates them to do
those things that support the business plan - The type and amount
of compensation necessary to attract technically and culturally
qualified international managers and technical professionals to the
three nationals or country categories involved international human
resource management activities from which employees are selected
whether the people are: PCNs (parent country nationals) TCNs (third
country nationals) or HCNs (host country nationals) - HR managers
focus on their strategic objectives to develop a comprehensive
compensation plan, in terms of considering base pay, short and
long-term incentives, benefits and growth opportunities - The
objective of this kind of strategy is to ensure that both TNC/MNCs
long and short-term objectives coexist in the compensation system
without overlap, which would duplicate a single pay plan for the
same objectives. - The purpose of the planning is also designed to
ensure that the compensation system attracts and retains the
desired employees and that it motivates them to do those things
that support the business plan Global Staffers An expatriate is an
employee working in a country other than their country of origin.
An expatriate may also be referred to as a PCN or parent-country
national - PCNs (Parent Country Nationals) Those personnel who are
of the same nationality as the contracting 39
government or personnel from headquarte