compensation management theory notes

8/9/2019 Compensation Management Theory Notes

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COMPENSATION MANAGEMENT

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Unit I

INTRODUCTION TO COMPENSATION

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-economicstability 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.

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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 employmentlevels and low inflation, for instance. An inordinately high minimum wage

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 Strategy-

For any / all of the following reasons:

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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 better4 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 paystructures

9 Providing value for money by evaluating the costs as well as

benefits of reward management practices

10Facilitating easy understanding by all, including employees,

operating managers and HR personnel

11Providing value for money by evaluating the costs as well as

benefits of reward management practices

12Easy 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

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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 performance4. 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 personnel3.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

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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

B In-kind claims are claims on goods & services made available & paid

for either totally or in some percentage by the employer

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 purchasing2.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 theemployee

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,

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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

* firm’s 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 &

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-

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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 disease–related materials,

reduced noise levels, clean workstation,- stress & technological advancements – affect emotional well-

being of the individual: providing a stable & secure lifestyle,

training & development opportunities to overcome health-related

problems

• Promote constructive social relationships with

coworkers

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- 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 & maliciousdamage

• 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

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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

- 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

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- 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 month’s pay) – paid @ 15 days wage for

every completed year of service with a maximum of 45 days wage in

a yearLay-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

Workmen’s compensation – workmen’s 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,

dependent’s benefit, medical benefitCanteen 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

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 serviceGratuity – 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

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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 café, 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

memberPersonal 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

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TOTAL COMPENSATION

COMPENSATION STRUCTURE – VARIOUS PERSPECTIVES

SALARY TRENDS

AVERAGE SALARY INCREASE IN TOTAL COST TO COMPANY (TCC) FOR

THE YEAR 2006 ACROSS ASIA PACIFIC –

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1 Average salary hike in 2006 for India at 14%, making it the highestin Asia Pacific

2 Employees in management staff cadre received average salary hikeof 16% in 2006

PERFORMANCE LINKED AWARDS

VARIABLE PAY TREND

1 Employee expectations are on the rise2 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,

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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

Organization’s 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 COMPENSATIONSKILL-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

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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 torecognize 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 narrowlydefined grades, each with a relatively limited pay range

* such structures create in employees a strong motivation to

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

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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 theorganization 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 &

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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 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 issubject 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

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linking their performance more closely to the employer’s 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 that’s 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

links overall compensation strategy with the organization’s

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

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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 employee’s 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 acash 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 theentire corporation’s 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 corporation’s

performance

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

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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 penaltiesand 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 isn’t always

Performance measurement

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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 significantpractical problem in VPLP

- even harder to manage is the problem of perception: even where

there are real, perhaps obvious, performance differences, the

employee who doesn’t 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

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something you can measure and understand—something 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

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

shareholder’s wealth since a sustained increase in EVA brings

increase in market value of the company

Incorporates 2 principles of finance into management decision –

making

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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, investor’s confidence &

employee motivation

Steps for implementing EVA-

Measuring 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 wealththat 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 PayGainsharing

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

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).

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Gainsharing: A technique that compensates workers based on

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 worker’s

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?

• 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• Helps companies achieve sustained

increases in productivity.• Employees become more involved the

productivity gains made by the

employer.

• Employees can share in the benefits

of employee sponsored

improvements.

• Enhances commitment to

organizational goals.

• Leads to improvements in other

measures of company performance,

including: teamwork, productquality, lower rates of absenteeism,

defects, and "downtime."

Disadvantages• 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.

• The formulas and program may be

difficult to understand.

• Requires a shift to a more team

oriented management style.

When does Gainsharing work best?

Works best when company performance levels can be easily quantified.

Employee involvement significantly enhances the effectiveness of

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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

• Brings groups of employees to work

together toward a common goal (the

success/benefit of the company).

• Helps employees focus on

profitability.

• The costs of implementing the plan

rise and fall with the company's

revenues.

• Enhances commitment to

organizational goals.

Disadvantages

• The pay for each employee moves up

or down together (no individual

differences for merit or performance).

• Focuses only on the goal of

profitability (which may be at the

expense of quality).

• For smaller companies, these plans

may result in drastic swings in

earnings for employees which the

employees may find difficult to

manage their personal finances.

• Adherence to the FLSA requires

employers to recalculate each

worker's "regular rate" of pay. Toovercome this limitation, employers

may restrict this type of

compensation to exempt employees.

When does Profit sharing work best? When company earnings are

relatively stable (or steadily increasing).

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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 theamount 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 company’s

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 samein 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

o Allows a company toshare ownership with the

employees.

o Used to align the

interests of the employees

with those of the company.

Disadvantages

o In a down market, because they quickly

become valueless

o Dilution of

ownership

o Overstatement of

operating income

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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

o Aligns executive and

shareholder interests.

o Company receives

tax deduction.

o No charge to

earnings.

Disadvantages

o Dilutes EPS

o Executive

investment is required

o 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

o Aligns executive and

shareholder interests.

o No executive

investment required.

o If stock appreciates

after grant, company's tax

deduction exceeds fixed

charge to earnings.

Disadvantages

o Immediate dilution

of EPS for total shares

granted.

o Fair-market value

charged to earnings over

restriction period.

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

o Aligns executives

and shareholders if stock is

used.

o Performance

oriented.o No executive

investment required.

o Company receives

tax deduction at payout.

Disadvantages

o Charge to earnings,

marked to market.

o Difficulty in setting

performance targets.

When do Stock options work best?

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-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.

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 baseddeferred 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 periodStock 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

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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

ESOP’s 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 performancesince investment is through employer’s 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 company’s shares

which can be sold or transferred to employees in future

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 &

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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 marketprice 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 sharesNotional units apportioned to employees

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

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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 company’s 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

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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.

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 ofparticipation 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. Ifemployees become disabled or die, they or their beneficiaries receive

the vested portion of their ESOP accounts right away.

Advantages

• Capital Appreciation. Companies

sell some or all of their equity to

employees and by doing so convert

corporate and personal taxes into

tax-free capital appreciation. This

allows the owner to sell 100% of his

or her company, get money out tax-free and still maintain control of the

company.

• Incentive Based Retirement.

Provides a cost-effective plan to

motivate employees. After all, who

works harder, owners or employees?

• Tax Advantages. Enables tax

Disadvantages

• Dilution. If the ESOP is used to

finance the company’s growth, the

cash flow benefits must be weighed

against the rate of dilution.

• Fiduciary Liability. The plan

committee members who administer

the plan are deemed to befiduciaries, and can be held liable if

they knowingly participate in

improper transactions.

• Liquidity. If the value of the stock

appreciates substantially, the ESOP

and/or the company may not have

sufficient funds to repurchase stock,

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advantaged purchasing of stock of a

retiring company owner. With this

purpose, a company owner may sell

their shares to the ESOP and incur

no taxable gain on the sale. A

company owner can sell all or someof the company to the employees cost

free. Owners who sell 30% or more of

their 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.

upon employees’ retirement.

• Stock Performance. If the value of

the company does not increase, the

employees may feel that the ESOP is

less attractive than a profit sharing

plan. In an extreme case, if thecompany fails, the employees will

lose their benefits to the 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 company’s

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 thatan 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

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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.

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, railwaycompanies, 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

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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 indecision-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.

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.

iii. The absence of regular feedback on performance.

iv. The reward system is not designed to meet the objectives sought to

be achieved. There could be a variety of objectivese.g. to satisfy

distributive justice, attract and retain capable staff, matchparticular levels of pay in the labour market, change organizational

culture (e.g. towards greater customer satisfaction) or to reinforce

it.

v. The absence of a right mix of extrinsic and intrinsic rewards.

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vi. 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.

vii. The absence of periodic evaluation of the scheme.

viii. Non-recognition of the fact that performance, especially profit, is

sometimes (even often) dependent on factors outside the control of

employeese.g. management decisions, exchange rates, recessions.

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

• where profits reduce, the reduction in the performance-related pay

can cushion employees against redundancies

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• 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. where the performance earnings fall employees are less inclined to

accept reductions in their guaranteed pay

ii. positive employment effects could be negated due to opposition

from employees to recruitment as it would dilute their earnings

iii. 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.

iv. it is difficult to determine whether the amounts paid out under

schemes are more than matched by performance gains.

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.

Unit II : 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“

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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

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 subsistencelevel 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

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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

/ wage to attract employees while employees compete with

another for jobs by offering their services for a lower wage

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- Competition then, is essentially a disequilibrium process by

which excess demand and excess supply cause changes in

wages

•

Behavioral Theories A. Employee’s 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 theorganization

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.

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• 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 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 oureconomic 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

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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 Man—a 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

corporations—private, public and government-owned—employed

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 Indian Administrative Service (IAS) or Police Service (IPS) was the

dream

• In the US, President Kennedy’s "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 everyone—from the mailroom clerk and janitor to

shop floor workers, supervisors and managers; and everyone else in

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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 fromOrganization 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, personalgrowth, and self-fulfillment

This group also tends to be more educated than

their predecessors, in most cases, they are more educated than their

supervisors

Impatience and self-confidence define today's

educated young worker

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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

compensation management theory notes

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