B.

Com (Hons) III Year

PAPER XXVIII : COMPENSATION MANAGEMENT

Lesson : 1 - 10

Department of Commerce
Editor : K.B. Gupta

SCHOOL OF OPEN LEARNING

UNIVERSITY OF DELHI
5, CAVALRY LANE, DELHI -110007

108
 LESSON 1

COMPENSATION
Dr. Neetu Jain
RDIAS
Institute of Management
Employee Compensation is a vital part of Human Resource Management. Wages, Salaries, and other
forms of employee compensation constitute a very large component of operating costs. No organization
can expect to attract and retain qualifies and motivated employees unless it pays them fair compensation.
“Compensation which includes direct cash payments, indirect payments in the form of employee
benefits and incentives to motivate employee to strive for higher level of productivity is a critical
component of the employment relationship. Compensation is affected by forces as diverse as labour
market factors, collective bargaining, government legislation and top management’s philosophy regarding
pay benefits.”
Wayne F Cascio
Employee Compensation may be classified into two categories
i) Base or Primary Compensation
ii) Supplementary compensation
Base or Primary compensation refers to basic pay in the form of wages and salaries. It is a fixed and
non incentive payment on the basis of time expended on the job.
Supplementary compensation consists of incentives and variable payments , based on either individual
output or output of the group as a whole.
Administration of Employee Compensation is called Compensation Management or wage and salary
administration. It involves formulation and implementation of policies and programmes relating to wages,
salaries and other forms of employee compensation. It involves Job evaluation ,wage/ salary survey,
development and maintenance of wage structure rules for administration of wages, profit sharing and
other incentives and control of payroll costs. The basic purpose of wage and salary administration is to
establish and maintain an equitable wage and salary structure and an equitable labor cost structure.
Base Compensation
Base compensation involves monetary benefits to employees in the form of wages or salaries. The
term ‘wage’ is used to denote remuneration to workers doing manual or physical work. Thus, wages are
given to compensate the unskilled workers for their services rendered to the organization. Wages may
be based on hourly, daily, weekly or even monthly basis. But the term ‘salary’ is usually defined to mean
compensation to office employees, foremen, managers and professional and technical staff. It is generally
paid on weekly, monthly or yearly basis. Thus, the time period for which salaries are paid is generally
higher than in case of wage payments.
Wages may be based on the number of units produced(i.e., piece wage system) or the time spent on
the job. But salary is always based on time spent on the job. Where it is difficult to measure the
production of the employee, the compensation is paid in the form of salary. Both wages and salaries
constitute a significant portion of the cost of operation of business.
Supplementary Compensation: Fringe Benefits
Modern organizations use supplementary compensation over and above base compensation to retain
the employees on a long term basis. Supplementary compensation involves ‘fringe benefits’ offered
through several employee services and benefits such as housing, subsidized food, medical aid ,crèche, etc.
Supplementary compensation has been given different titles in industry such as ‘service programmes’,
‘employee benefits’ and ‘non-wage payments’. Because of the increasing costs of fringe benefits’ some
people also label them ‘hidden payroll’.
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 The basic purpose of fringe benefits or supplementary compensation are :
(1) to attract and maintain efficient human resources with the organization; and
(2) to motivate the human resources.
Types of Supplementary Compensation
Fringe benefits or ‘supplementary compensation’ involve all expenditures by an employee designed
to benefit employees over and above regular base pay and direct variable compensation related to output.
According to Edwin B Flippo(1989), fringe benefits may include the following:
1. Payment for time not worked. Example in this area include paid rest periods, paid lunch
periods, wash-up time, clothes –change time, get ready time, vacations, holidays, sick leave,
personal leave, voting time, etc. There is seemingly no end to the innovation of new reasons for
“not working” for pay.
2. Hazard protection. There are a number of hazards that might be faced by all. Income
maintenance during these periods is the purpose of fringes designed to protect against the,
hazards of illness, injury, debt, unemployment, permanent disability, old age, and death.
3. Employee services. Big organizations offer certain employee services on a continuing basis, such
as housing, food, medical, recreation, and so on. They have such fringe-benefit programmes as
cafeterias, career counseling, educational tuition, aid in housing, medical services, low –cost
loans, use of organization vehicles for personal use, day-care centers for children and paid
memberships in certain professional organizations.
4. Legal payments. In most countries, the governments have passed several laws for protecting
employees against the major hazards of life. Payments under this category may involve
unemployment or lay-off compensation, employees ‘insurance, old-age benefits under social
security, etc.
The list of fringe benefits has increased manifold over the years and the expenditures on such
programmes have in many cases equalled or exceeded the base wage compensation to the employees.
That is why, the term ‘fringe’ is deemed no longer appropriate and it is replaced by terms such as
‘employee benefits’ and ‘employee services’.
Perquisites
Several new benefits have been initiated by industrial giants particularly for the executives. Such
benefits are referred to as ‘perquisites’ or ‘perks’. Perks include chauffeur driven car, corporate aircraft
, home security, company apartment, club membership, paternity leave, self-defence training, company
credit card, entertainment, etc.
Compensation Management
Compensation management has been a very important source of attracting, retaining and motivating
the required human resource for any organization .Compensation Management is an integral part of the
management of the organization. It contributes to the overall success of the organization in several ways.
To be effective, the managers must appreciate the value of competitive pay and their human resources
Although most employees specially at middle and senior levels claim that money does not play
a very important role in their decision to change or stay in an organization but in reality it is the money
which motivates most of the employees. The employees need to be compensated for the services which
they render to an organization. It is not easy to work out suitable compensation package for the
employees and keep them satisfied .The experience is that the employees mostly remain dissatisfied
with whatever wage and salary they are paid by the employers . Therefore , the job of wage and salary
administration has been complex and subtle, and littered with techniques to reduce the complexity and
cope with the subtleties.

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 These days, the organizations are also beset with the problem of ‘take home salary concept’. The
organizations are finding ways to help employees in planning their tax liability or rather how to minimize
their tax liability. On the other hand government has been finding loopholes in the tax structure to plug
the same .Recently , there has been a number of cases where very large organization have been caught
for not deducting tax at source properly. As a result , today we find the number of components of the
compensation have been increased and the nomenclature of these components have been changed to
keep the same out of the income tax net by the management under the pressure of its employees.
The employees work for rewards and the employers seek higher productivity to keep cost per employee
low. A balance is to be struck between these two parties – employer and employee with regard to
compensation . The compensation should be designed in such a fashion that the organization is able to
attract, motivate, an retain competent employees and at the same time the employees perceive it fair and
equitable. In India , the government , specially through labour laws has been playing a very important
and significant role in determining wages and also in making it mandatory for employees to provide
welfare schemes to its work force.
Objectives of Compensation Management
It is very necessary to list the various objectives which can be achieved through Compensation
Management and the same have been given below:
1. Acquire qualified personnel
Compensation needs to be high enough to attract applicants. Pay levels must respond to supply and
demand of workers in the labour market since employers compete for workers.
2. Retain present employees
Employees may quit when compensation levels are not competitive resulting in higher turnover. Therefore,
one of the important objective of Compensation Management is retaining the human capital or talent of
the organization.
3. Ensure equity
Compensation Management strives for internal and external equity which requires that pay is related to
the relative worth of the jobs and is comparable to what other workers are getting in the other firms.
4. Reward desired behaviours
Pay should reinforce desired behaviour and act as incentive for those behaviours to occur in future .
5. Control costs
A rational compensation system helps the organization obtain and retain workers at reasonable cost.
6. Comply with legal regulations
A sound wage and salary system considers the legal challenges imposed by the government and ensures
the employers compliance.
7. Facilitate understanding
The Human Resource specialists, operating managers and employees should easily understand the
compensation management .
8. Further administrative efficiency
Wages and salary programmes should be designed to be managed efficiently , making optimal use of
HRIS i.e Human Resource Information System.
Sometimes these objectives may conflict with one another and trade-offs must be made between
them. These objectives are not the rules instead these are the guidelines.

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Principles of Wage and Salary Administration
Wage administration should be guided by following basic considerations:
1. Wage policies should be carefully developed , having in mind the interests of
(a) management as the representative of the owners
(b) the employees
(c) the consumers
(d) the community
2. Wages policies should be clearly expressed in writing to ensure uniformity and stability.
3. Wage decisions should be checked against the carefully formulated policies.
4. Management should see to it that the employees know and understand the wage policies.
5. Wage policies should be evaluated from time to time to make certain that they are adequate for
current needs.
6. Departmental performance should be checked periodically against the standards set in advance.
7. Job descriptions and performance ratings should be checked periodically to keep them up to date.
D.S. Beach has provided following seven principles of Compensation Management-:
1. The enterprise should have a clear-cut plan to determine differential pay levels in terms if
divergent job requirements involving varied skills, effort, responsibility and working conditions.
2. An attempt should be made to keep the general level of wages and salaries of the enterprise in
line with that obtained in the labour market or industry.
3. Adequate care should be taken to distinguish people from the jobs. Although people are paid in
terms of rate embodied in specific jobs, some exceptions should be allowed in the cases of
professional and executive personnel by paying them in terms of their abilities and contributions.
4. Irrespective of individual considerations, care should be taken to ensure equal pay for equal work
depending upon flexibility of jobs – of course, variations may be permitted within a pay-range.
5. There should be a plan to adapt an equitable measure for recognizing individual differences in
ability and contribution in the form of rate ranges with in-grade increments, wages incentive
schemes and a system of job promotion.
6. The attempt should be made to provide some procedure for handling wage grievances. This can
be effectively embodied in the normal grievance procedure obtained in the enterprise.
7. Adequate care should be taken to inform the employees and the union, if any, about the procedure
followed in determining wage rates. There should be no confidential issues in respect of wages
and every employee should have a clear understanding of his/her wage or salary structure on an
individual basis. This will enhance employee satisfaction with wages.
Factors Influencing Employee Remuneration
A number of factors influence the remuneration payable to employees. They can be categorized into
(i) external and (ii) internal factors.
External Factors
Factors external to an organization are labour market, cost of living, labour unions, government
legislations, the society, and the economy.
Labour Market
Demand for and supply of labour influence wage and salary fixation. A low wage may be fixed when
the supply of labour exceeds the demand for it. A higher wage will have to be paid when the demand
exceeds supply, as in the case of skilled labour. A paradoxical situation is prevailing in our country—
excessive unemployment is being juxtaposed with shortage of labour. While unskilled labour is available
in plenty, there is a shortage of technicians, computer specialists and professional managers. High
remuneration to skilled labour is necessary to attract and retain it.
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 But exploitation of unskilled labour, like, for instance, paying niggardly wages because it is available
in plenty, is unjustifiable. The Minimum Wages Act, 1948, is precisely meant to prevent this kind of
exploitation.
Going rate of pay is another labour-related factor influencing employee remuneration. Going rates
are those that are paid by different units of an industry in a locality and by comparable units of the same
industry located elsewhere. This is the only way of fixing salary and wage in the initial stages of plant
operations. Subsequently, a comparison of going rates would be highly useful in resolving wage-related
disputes.
Productivity of labour also influences wage fixation. Productivity can arise due to increased effort
of the worker, or as a result of the factors beyond the control of the worker such as improved technology,
sophisticated machines and equipment, better management, and the like. Greater effort of the worker is
rewarded through piece-rate or other forms of incentive payments. This form of productivity, due to
individual effort, cannot form a criterion of general wage movements.
Productivity arising from advanced technology and more-efficient methods of production will influence
wage fixation. While productivity can be measured in terms of any one of the several factors such as
capital equipment, materials, fuel and labour, what matters most is labour productivity. It is the relationship
between the input of labour measured in man-hours and the output of the entire economy, or of a
particular industry or plant measured in terms of money or in physical terms. It may be stated that
productivity has only subordinate role in wage fixation. It can, at best, help determine fair wages.
Productivity linked wages may help utilize human resources better. This is particularly relevant to our
country where productivity is very low. However, the argument that productivity would increase if it is
linked to remuneration is hardly acceptable to labour and labour organizations.
Cost of Living
Next in importance to labour market is the cost of living. This criterion matters during periods of
rising prices, and is forgotten when prices are stable or falling. The justification for cost of living as a
criterion for wage fixation is that the real wages of workers should not be allowed to be whittled down
by price increases. A rise in the cost of living is sought to be compensated by payment of dearness
allowance, basic pay to remain undisturbed. Many companies include an escalatory clause in their wage
agreements in terms of which dearness allowance increases or decreases depending upon the movement
of consumer price index (CPI).
Labour Unions
The presence or absence of labour organizations often determine the quantum of wages paid to
employees. Employers in non-unionised factories enjoy the freedom to fix wages and salaries as they
want. Because of larger-scale unemployment, these employers hire workers at little or even less than legal
minimum wages. An individual non-unionized company may be willing to pay more to its employees if
only to discourage them from forming one, but will buckle under the combined pressure from the other
non-unionised organizations. The employees of strongly unionized companies too, have no freedom in
wage and, salary fixation. They are forced to yield to the pressure of labour representatives in determining
and revising pay scales.
Union Influences on Compensation Decisions
Unions and labor relations laws also influence pay plan design. Various labor legislations and court
decisions legitimized the labor movement. They gave unions legal protection and granted employees the
right to organize, to bargain collectively, and to engage in concerted activities for the purpose of collective
bargaining or other mutual aid or protection. Historically, the wage rate has been the main issue in
collective bargaining. However, unions also negotiate other pay related issues, including time off with
pay, income security (for those in industries with periodic layoffs), cost-of-living adjustments, and benefits
like health care.

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Labour Laws
We have a plethora of labour laws at the central as well as at the state levels. Some of the central
laws which have a bearing on employee remuneration are the Payment of Wages Act, 1936; the Minimum
Wages Act, 1948; the Payment of Bonus Act, 1965; Equal Remuneration Act, 1976; and the Payment of
Gratuity Act, 1972. The Payment of Wages Act was passed to regulate payment of wages to certain
classes of persons employed in the industry. It also seeks to protect workers against irregularities in
payment of wages and unauthorized deductions by the employers. In addition, the Act ensures payment
of wages in a particular form and at regular intervals. The Minimum Wages Act enables the central and
the state governments to fix minimum rates of wages payable to employees in sweated industries. The
Payment of Bonus Act provides for payment of a specified rate of bonus to employees in certain
establishments. The Gratuity Act provides for payment of gratuity to employees after they attain
superannuation. The Equal Remuneration Act provides for payment of equal remuneration to men and
women workers for same or similar work. The Act stipulated stringent punishments for contravention of
its provisions.
In addition to legal enactments, there are wage boards, tribunals and fair wages committees which
aim at providing a decent standard of living to workers. In fact, ours is the only democratic country in
the world which has attempted wage regulation on such large scale through state-sponsored agencies.
With regard to managerial remuneration, there is the Companies Act, 1956, which puts a cap on
salary and perquisites of managers. Sections 198 and 309 of the contain provisions relating to managerial
remuneration. As per the new guidelines issued on July 14, 993, the remuneration payable to managerial
personnel comprises:
1. Salary of Rs 6,00,000 per annum or Rs 50,000 per month including dearness and all other
allowances.
2. Perquisites which shall be restricted to an amount equal to the annual salary or Rs 4,50,000 per
annum, whichever is less.
3. Commission in addition to salary or perquisites or both. The amount of commission based on
the net profits of the company in a particular year shall be subject to the overall ceilings as laid
down in Sections 198 and 309.
Society
Remuneration paid to employees is reflected in the prices fixed by an organization for its goods and
services. The Supreme Court, from its very inception, has had to adjudicate industrial disputes—particularly
disputes relating to wages and allied problems of financial concern to the worker- an ethical and social
outlook liberally interpreting the spirit of the Constitution. In Standard Vacuum Refixing vs. Its Workmen
(1961), the apex court observed:
“It is well-known that the problem of wage structure with which industrial adjudication is concerned
in a modern democratic state involves, in the ultimate analysis, to some extent ethical and social
considerations, The advent of the doctrine of a welfare state is based on notions of progressive social
philosophy which have rendered the old doctrine of Laissez Faire obsolete.”
Though the financial position of the employer and the state of the national economy have their say
in the matter of wage fixation,
the requirements of a workman living in a civilized and progressive society also came to be recognized.
Hence, according to the Supreme Court, the social philosophy of the period provides the background
for decisions on industrial disputes relating to the wage structure.
The Economy
The last external factor that has its impact on wage and salary fixation is the state of the economy.
While it is possible for some organizations to thrive in a recession, there is no question that the economy

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does not affects remuneration decisions. For example, a depressed economy will probably increase the
labour supply. This, in turn, should serve to lower the going wage rate.
In most cases, the cost of living will rise in an expanding economy. Since the cost of living is
commonly used as a pay standard, the economy’s health exerts a major impact upon pay decisions.
Labour unions, the government, and the society are all less likely to press for pay increases in a depressed
economy.
Internal Factors
Among the internal factors which have an impact on pay structure are the company’s strategy, job
evaluation, performance appraisal, and the worker himself or herself.
Business Strategy The overall strategy which a company pursues should determine the remuneration
to its employees. Where the strategy of the enterprise is to achieve rapid growth, remuneration should
be higher than what competitors pay. Where the strategy is to maintain and protect current earnings,
because of the declining fortunes of the company, remuneration level needs to be average or even below
average.
Job Evaluation and Performance Appraisal Job evaluation helps establish satisfactory wage
differentials among jobs. Performance appraisal helps award pay increases to employees who show
improved performance.
The Employee Several employee-related factors interact to determine his or her remuneration. These
include performance, seniority, experience, potential, and even sheer luck.
Performance is always rewarded with a pay increase. Rewarding performance motivates the employee
to do better. Managements prefer performance to effect pay increases but unions view seniority as the
most objective criterion for pay increases. Experience makes an employee gain valuable insights and
should therefore be rewarded. Potential is useless if it is never realized. Yet, organizations do pay some
individuals based on their potential. Young managers are paid more because of their potential to perform
even if they are short of experience. Some people have luck to be at the right place at the right time.
Criteria of Effective Compensation Programme
According to John M. Ivancevich (1955), the objective of compensation function is to create a system
of rewards that is equitable to the employer and the employees alike. He quoted Patton (1977) who has
suggested seven criteria to judge the effectiveness of compensation:
l Adequate : Minimal governmental, union, and managerial levels should be met.
l Equitable: Each person should be paid fairly, in line with his or her effort, abilities and training.
l Balanced : Pay, benefits and other rewards should provide a reasonable total reward package.
l Cost effective: Pay should not be excessive, considering what the organization can afford to pay.
l Secure: Pay should be enough to help an employee feel secure and aid him or her in satisfying
basic needs.
l Acceptable to the employee: The employee should understand the pay system and feel it is a
reasonable system for the enterprise and himself or herself.
l Incentive providing: Pay should motivate effective and productive work.
Principles of Compensation Management
There are certain guiding principles which provide the foundation for effective reward management.
They are as under:
1. Wage policies are to be carefully developed, having in mind interests of :
(a) Owners/ managers
(b) Employees
(c) Community

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 2. Wage policies must be clearly expressed to ensure uniformity and stability. It should not frequently
vary. It should be known to all the members of the management team so as to avoid expediency.
3. Wage decisions should be checked against formulated policies.
4. It has to be ensured that employees know and understand the wage policies. There should be
clearly established procedures for hearing wage complaints.
5. Wage policies are to be evaluated periodically to ensure they are adequate for current needs.
6. Some companies have wage and salary committee for establishing wage polices and to recommend
changes.
7. Prompt and correct payment of the dues of the employees must be ensured. It should be capable
of easy and quick calculation. Some principles governing the fixation of wages and salaries are
also to be borne in mind. These can be made elements of wage policy.
8. There should be definite plan to ensure that differences in pay for jobs are based upon variations
in job requirements, such as skill, effort, responsibility, working, conditions, mental and physical
requirements within the organization.
9. The general level of wages should be in line with that prevailing in the labour market i.e., of
competitors in the area and industry.
10. Principle of equal pay for equal work is to be followed to avoid inequites.
11. The wage should be adequate to ensure for the worker and his family, a reasonable standard of
living.
12. The wage and salary payments should fulfill a wide variety of human needs including the need
for self-actualization.
13. Wage and salary level should be adequate to attract, retain and motivate competent employees
to perform their tasks.
14. Wage and salary policy should recognize changes in cost of living and productivity.
M. Armstrong et al. list down the following principles as foundations for effective reward management:
1. Align reward strategies with the business strategy;
2. Align rewards policies with the culture of the organization and use them to underpin that culture
and if required, help to change it;
3. Value employees according to their competence, skill and contributions;
4 Remember that reward management is about the management of diversity, not the control of
uniformity;
5. Ensure that reward processes are transparent and that employees are treated as stockholder;
6. Adopt an integrative approach which ensures that no innovations take place and no practices are
changed without considering how they relate to other aspects of human resource management so
that they can become mutually supportive;
7. Provide line managers with the authority and skills needed to use rewards to help achieve their
goals, but ensure that they are given the training, guidance and continuing support required to
develop and use these skills well;
8. Remember that pay delivery process can produce significant performance coverage and motivation,
therefore develop and apply them accordingly;
9. Remember that reward policies and practices should be driven by the need to reward the right
things, and to convey the right message about what is important.
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Compensation Practices
An organization has to design its compensation system in such ways that it is able to attain its three
main objectives, namely :
(1) Attracting the talent : It is widely accepted that human resources of an organization give it an
edge over its competitors. By offering a well designed pay package, an organization can get best
talent available in the job market.
(2) Retaining the talent : In present times, because of globalization and subsequent privatization, the
workforce has become highly mobile. The practice of lifelong employment and commitment
between the employer and the employee which was practiced in some economies of the world
(William Ouchi’s Theory Z on motivation) is fast disappearing. Now, employees do not hitch
leaving one job and joining the other if they are offered better pay package. Therefore, organizations
have to design such compensation systems that talent and skill not only gets attracted but also
stay with the organization.
(3) Motivating the employees : Employees may have talent but they will not be motivated to use their
talent unless they know that they will be rewarded duly for their contribution towards organizational
objectives or be punished for not contributing as per the demands of the job.
For attracting the talent towards the organization, it is necessary that each organization should design
a compensation system that is externally competitive. With that end in mind, wage and salary surveys
are to be conducted and pay levels be determined accordingly.
For retaining the people in organizations, organizations conduct job evaluation which is a process to
determine the relative worth of each job. Such evaluation results in building up a pay structure that
satisfies people about the internal equity of pay that they get. Results of market surveys and job evaluation
are aligned with each other so as to design a pay level and pay structure that is good enough to attract
and retain people in organization .
For motivating the employees, it is necessary that besides external and internal equity, they also feel
that they are being paid for their contributions i.e. the practice of variable pay is followed in the
organization. The philosophical foundation of variable pay rests on the following basic assumptions:
(a) Some jobs contribute more to organizational success than some others
(b) Some people perform better than others.
(c) Employees who perform better should receive more compensation
(d) A portion of some employee’s total compensation should be contingent on performance.
The various types of pay plans have been shown in Exhibit

Types of Variable Wage Plans

Individual Group/Team Organization Wide

l Piece rate l Gains sharing l Profit sharing
l Sales commissions l Quality improvement l Employee stock Options
l Bonuses l Cost reduction l Deferred compensation
l Special recognitions
(trips, merchandise)
l Safety awards
l Attendance bonuses

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Establishing Pay Rates
The process of establishing pay rates while ensuring external, internal, and (to some extent) procedural
equity consists of five steps:
1. Conduct a salary survey of what other employers are paying for comparable jobs (to help ensure
external equity).
2. Determine the worth of each job in your organization through job evaluation (to ensure internal
equity).
3. Determining Pay Grade
4. Pricing jobs and establishing Pay levels
5. Fine Tuning Rates of Pay
1. Pay/Salary Surveys
Job hierarchy being established, the next step is to establish pay differentials. Before fixing wage and
salary differentials, prevailing wage and salary differentials, prevailing wage and salary rates in the labour
market need to be ascertained. Hence the relevance of pay surveys.One way of collecting pay details is
to conduct a survey. This requires that a sample of key jobs and a sample of companies need to be
selected. Questionnaires could be mailed to select companies, requesting them to furnish pay details
relating to key jobs. Information can also be collected over ate telephone.
There are also other sources of collecting pay details. Labour departments of the government, trade
unions, and professional bodies, and consulting firms provide copious amount of information about the
prevailing wage and salary rates.
Before fixing wage and salary differentials, prevailing wage and salary differentials, prevailing wage
and salary rates in the labour market need to be ascertained. Hence the relevance of pay surveys.
One way of collecting pay details is to conduct a survey. This requires that a sample of key jobs and
a sample of companies need to be selected. Questionnaires could be mailed to select companies, requesting
them to furnish pay details relating to key jobs. Information can also be collected over ate telephone.
There are also other sources of collecting pay details. Labour departments of the government, trade
unions, and professional bodies, and consulting firms provide copious amount of information about the
prevailing wage and salary rates.
It is difficult to set pay rates if you don’t know what others are paying, so salary surveys play a big
role in pricing jobs. Virtually every employer conducts at least an informal telephone, newspaper, or
Internet salary survey.
Employees use these surveys in three ways. First they use survey data to price benchmark jobs. They
then use these as the anchors around which they slot their other jobs, based on each job’s relative worth
to the firm. (Job evaluation, explained next, helps determine the relative worth of each job.) Second,
employers typically price 20% or more of their positions directly in the marketplace (rather than relative
to the firm’s benchmark jobs) based on a formal or informal survey of what comparable firms are paying
for comparable jobs. (A dot-com firm might do this for jobs like web programmer whose salaries
fluctuate widely and often.) Third, surveys also collect data on benefits like insurance, sick leave, and
vacations to provide a basis for decisions regarding employee benefits.
Salary surveys can be formal or informal. Informal telephone or Internet surveys are good for
checking on a relatively small number of easily identified and quickly recognized jobs, such as when a
bank’s HR director wants to confirm the salary at which to advertise a newly open cashier’s job. Such
informal techniques are also good for checking discrepancies, such as when the HR director wants to find
out if some area banks are really paying tellers on some sort of incentive plan. Perhaps 20% of large
employers use their own formal questionnaire surveys to collect compensation information from other
employers. Most of these ask about things like number of employees, overtime policies, starting salaries,
and paid vacations.
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2. Job Evaluation
Job evaluation is aimed at determining a job’s relative worth. It is a formal and systematic comparison
of jobs to determine the worth of one job relative to another and eventually results in a wage or salary
hierarchy. The basic principle is this: Jobs that require greater qualifications, more responsibilities, and
more complex job duties should be paid more highly than jobs with lesser requirements. The basic
procedure is to compare the jobs in relation to one another-for example, in terms of required effort,
responsibility, and skills. Suppose you know (based on your salary survey) how to price key benchmark
jobs, and then use job evaluation to determine the relative worth of all the other jobs in your firm relative
to these key jobs. You are then well on your way to being able to price all the jobs in your organization
equitably.
3. Compensable Factors
You can use two basic approaches to compare several jobs. First, you can take an intuitive approach.
You might decide that one job is more important than another and not dig any deeper into why. As an
alternative, you could compare the jobs by focusing on certain basic factors the jobs have in common.
Compensation management specialists call these compensable factors. They are the factors that establish
how the jobs compare to one another, and that determine the pay for each job.
Some employers develop their own compensable factors. However, most use factors popularized by
packaged job evaluation systems or by federal legislation. For example, the Equal Pay Act focuses on
four compensable factor-skills, efforts, responsibilities, and working conditions. The method popularized
by the Hay consulting firm focuses on three factors: know-how, problem solving, and accountability. In
2004, Wal-Mart instituted a new wage structure based on knowledge, problem solving skills and
accountability requirements.
Identifying compensable factors plays a central role in job evaluation. You usually compare each job
with all comparable jobs using the same compensable factors. However, the compensable factors you use
depend on the job and the job evaluation method. For example, you might choose to include “decision
making” for a manager’s job. Though it might be inappropriate for a cleaner’s job.
Preparing for the job Evaluation Job evaluation is mostly a judgmental process, one demanding close
cooperation among supervisors, HR specialists, and employees and union representatives. The main steps
include identifying the need for the program, getting cooperation, and then choosing an evaluation
committee. The committee then performs the actual evaluation.
Identifying the need for job evaluation should not be difficult. For example, dissatisfaction reflected
in high turnover, work stoppages, or arguments may result from paying employees different rates for
similar jobs. Managers may express uneasiness with an informal way of assigning pay rates to jobs,
accurately sensing that a more systematic assignment would be more equitable.
Next (since employees may fear that a systematic evaluation of their jobs may actually reduce their
pay rates), getting employees to cooperate in the evaluation is second important step. You can tell
employees that as a result of the impending job evaluation program, pay rate decisions will no longer be
made just by management whim; that job evaluation will provide a mechanism for considering the
complaints they have been expressing; and that no present employee’s rate will be adversely affected as
a result of the job evaluation.
Next, choose a job evaluation committee. There are two reasons for doing so. First, the committee
should include several people who are familiar with the jobs in question, each of whom may have a
different perspective regarding the nature of the jobs. Second, if the committee is composed at least partly
of employees, the committee approach can help ensure greater employee acceptance of the job evaluation
results.
So the composition of the committee is important. The group usually consists of about five members,
most of whom are employees. Management has the right to serve on such committees, but employees may
view this with suspicion. However, an HR specialist can usually be justified on the grounds that he or
11
she has a more impartial outlook than line managers and can provide expert assistance. One option is to
have this person serve in a nonvoting capacity. Union representation is possible. In most cases, though,
the union’s position is that it is accepting the result of the job evaluation only as an initial decision and
is reserving the right to appeal actual job pricing decisions through grievance or bargaining channels.
Once appointed, each committee member should receive a manual explaining the job evaluation process,
and instructions that explain how to conduct the job evaluation.
The evaluation committee performs three main functions. First, it usually identifies 10 or 15 key
benchmark jobs. These will be first jobs to be evaluated and will serve as the anchor or benchmarks
against which the relative importance or value of all other jobs can be compared. Next, the committee
may select compensable factors (although the HR department will usually choose these as part of the
process of determining the specific job evaluation technique the firm will use). Finally, the committee
performs its most important function- actually evaluating the worth of each job. For this, the committee
will probably use one of the following methods: ranking, job classification, point method, or factor
comparison.
Job evaluation helps establish job hierarchy. Through surveys, the rate for key jobs in the labour
market is also known.
4. Determining Pay Grades
A pay grade comprises jobs of approximately equal difficulty or importance. Where point-ranking
method of job evaluation is used, the grade consists of jobs falling within a range of points. It is
convenient to organize jobs into groups, also called job classes, so that there are limited numbers of wage
rates. Where individual jobs are retained, an organization will have hundreds of remuneration rates.
The existence of hundreds of separate wage rates would be meaningless as differences between jobs
might be just a few rupees. Where grouping of jobs is done, the wage- curve line is to be replaced with
a series of ascending dashes, as shown in Figure Thus, all jobs in the same class will receive the same
wage rate. A job valued at 105 points, for example, receives the same pay as a job with 145 points .
Amount, $

0 101 151 201 251 301 351 401 451 501

100 150 200 250 300 350 400 450 500 550
I II III IV V VI VII VIII IX X
Fig. 11.7 The Impact of Job Classes on the Wage-trend Line
Source: William Werther and Keith Davis, Human Resoruces and Personnel Management, p. 394

12
3. Pricing jobs and establishing Pay levels
In pricing jobs, the job evaluation worth is matched with the labour-market worth. Two activities need
to be performed: (i) establishing the appropriate pay level for each job, and (ii) grouping the different pay
levels into pay grades.
Pay Levels
In order to set a pay level, the point assigned and the survey wage rates are combined through the use of
a graph called scattergram. As figure given below shows, the vertical axis represents pay rates. The horizontal
axis is used for points. The total points and the wage rates for each key job are plotted to obtain the scattergram.
Thus each dot in Fig. represents the intersection of the point value and the market-determined wage rate for
a particular key job. For example, key job A in the figure is worth 500 points and is paid Rs 60 per hour.
Similarly, key job B earns 700 points and has prevailing rate of Rs 70 per hr.

Point values
Fig. The Development of a Wage-trend Line
Source: William Werther and Keith Davis, Human Resources and Personnel Management, p. 393

The dots that represent key jobs can be used to draw a wage-trend line as, close to as many points as
possible, employing a statistical technique called least squires method of regression. This method relates
point values to wage rates in the labour market. If the employer wants to lead or lag behind the market rate
by a given percentage, the wage-trend line can be moved up or down by the same percentage.
5. Fine Tuning Rates of Pay
It involves correcting out of line rates and developing rate ranges:
1) Developing Rate ranges:
Most employers do not pay just one rate for all jobs in a particular pay grade. Instead they develop rate
ranges for each grade so that there might be different levels and corresponding pay rates within each pay
grade. The rate range is usually built around the wages line or curve.
One alternative is to arbitrarily decide on a maximum and minimum rate for each grade.As an alternative,
some employers allow the rate range for each grade to become wider for the higher pay ranges reflected the
greater demands and performance variability inherent in these more complex jobs.

13
 There are two major benefits of using rate ranges for each pay grade.Firstly, the employer can take a
more flexible stance with respect to the labor market.It becomes easier to attract experienced, higher paid
employees into a pay grade where the starting salary for the lowest step may be too low to attract such
experienced personnel.Secondly, rate ranges can also allow the mployer to provide for performance differences
among employees within the same grade or between those with different seniorities.
2) Correcting out of line range:
It may be found that the average current pay for a job is either too high or too low relative to oher jobs
in the firm. If a rate falls below the line, a pay rise for that job may be required. If the rate falls above the line,
pay cuts or a pay freeze may be required.
Underpaid employees should have their wages raised to the minimum of the rate range for their pay
grade, assuming the organization wants to retain those employees and has the funds to do so.
There are several ways to cope with overpaid employees:
i) To freeze the rate paid to employees in this grade unless general salary increases bring the other jobs
into line with it.
ii) To transfer or promote some or all of the employees involved to jobs for which they can legitimately
be paid their current pay rates.
Challenges Regarding Compensation Design
1. To Establish a Fair and Equitable Remuneration: There should be internal and external equity in
remuneration paid to employees. Internal equity means similar pay for similar work. In other words,
wage differentials between jobs should be in proportion of differences in the worth of jobs. External
equity implies pay for a job should be equal to pay for a similar job in other organisation. Payment
based on jobs requirements, employee performance and industry levels minimise favoritism and
inequities in pay.
2. To Improve Public Image of the Company : Wage and salary programme also seeks to project the
image of progressive employer and to comply with legal requirements relating to wages and salaries.
3. To Control Costs: Through sound wages and salary administration labour and administrative costs
can be kept in line with the ability of the company to pay. It facilitates administration and control of
pay roll. The company can systematically plan (payroll budgeting) and control labour costs.
4. To attract Competnet Personnel: A sound wage and salary administration helps to attract qualified
and hard-working people by ensuring and adequate payment for all jobs.
5. Clarity: Wage and salary plans should be stated clearly in writing to ensure uniform and consistent
application.
6. To improve Union Management Relation: Wages and salaries based on systematic analysis of jobs
and prevailing pay levels are more acceptable to trade unions. Therefore, sound wage and salary
administration simplifies collective bargaining and negotiations over pay. It reduces grievances arising
out of wage inequities.
7. Formulation and Implementation of Wage Policy: Management should ensure the employees know
and understand the wage policy of the company. Workers should be associated in formulation and
implementation of wage policy.
8. Flexibility: Wage and salary plans should be sufficiently flexible or responsive to changes in internal
and external condition of the organisation.
9. To Retain the Present Employees: By paying a competitive levels, the company can retain its
personnel. It can minimise the incidence of quitting and increase employee loyalty.
10. In Both Interest: Wage policy should be developed keeping in view the interests of the employees,
the employer, the consumers and community.

14
11. To Improve Productivity : Sound wage and salary administration helps to improve the motivation
and morale of employees which in turn lead to higher productivity.
12. Salary Decision: All wage and salary decisions should be checked against the standards set in advance
in the wage policy.
13. Periodical Changes: Wage policy and programme should be reviewed and revised periodically in
conformity with changing needs.
14. Consistent: Wage and salary plans should be consistent with the overall plans of the company.
Compensation planning should be an integral part of financial planning.
15. Wage and salary plans should simplify and expedite administrative process.
16. An adequate database and a proper organisational set up should be developed for compensation
determination and administration.
Consequences of Pay Dissatisfaction:
Pay is a critical factor in the work lives of employees. Jobs are accepted or rejected based in part on
starting salary and the opportunity for future increases in pay. Employees compare their pay to that of others
in the same line of work. They constantly compare their pay level to their level of contribution, trying to
determine whether the ratio of give and receive is a fair one. While it may not be a frequent topic of open
discussion, employees think about pay often.
If employees who are paid well can generate results for the organization, failed ones can create problems.
The major challenges what managers face today is retention of the man power and the major cause of it is
that they are paid better in the other organizations. A satisfied employee is a productive employee therefore,
care should be taken that they are fairly paid for their worth in the organization.
Job dissatisfaction is by definition unpleasant, and most individuals are conditioned, probably even
biologically-driven, to respond to unpleasant conditions by searching for mechanisms to reduce the
dissatisfaction.
This drive towards adaptation is as natural and inevitable in workplaces as it is in any other environment.
But for better or worse, it has gathered particular attention among organizational researchers because
employees’ adaptive mechanisms may operate in such a way as to affect organizationally-relevant outcomes,
ranging from changes in job performance to such withdrawal behaviors as absence or turnover.
Importance of an Ideal Remuneration System
An effective system of remuneration is highly significant because several problems relating to personnel
centre around one element, namely, remuneration. Many employees, for example, absent themselves from
work often because they feel they are not paid enough. They look for new and better prospects because the
present emoluments may not be attractive enough to stay on. They agitate, pelt stones, use foul language,
resort to graffiti, turn violent, fall sick, because the remuneration paid to them may not be adequate (see
Fig.) Performance

Desire for
More Pay
Absenteeism

Turnover

Psychological
Pay Lower Attractive- Withdrawal
Dissatisfaction ness of Job Job
Dissatisfaction Visits to the
Doctor
Absenteeism
Poor Mental
Health

Fig. Consequences of Pay Dissatisfaction

Source: William B. Werther and Keith Davis, Human Resources and Personnel Management, p, 412.

15
 Talks on job satisfaction, loyalty, organization before self, altruism, and the like, may be all right for
boardroom discussions, and for delivering lectures in classrooms. The talk may also be relevant in a
country like Japan, where people are inspired by a fanatical devotion to work. But in our country, an
average worker cares only for money. Such being the reality, remuneration must fulfill the expectations
and aspirations of employees and exploit their energies for the benefit of organizations.
Attractive remuneration enables an organization to attract, retain and motivate competent people.
Fresh MBAs and brilliant engineers flock around Hindustan Lever, Citibank, Motorola, ANZ Grindlays
and Reliance because of their attractive remuneration packages.
Retaining competent individuals for long is more difficult then attracting fresh ones. An employee’s
longevity of service in a particular organization depends more on non-financial benefits, but the role of
financial benefits cannot be ruled out, particularly at the lower levels of hierarchy. Loyalty towards an
organization also depends on his or her perceptions about remuneration. It is common knowledge that an
employee feels satisfied or dissatisfied with his or her remuneration—not so much by the total amount
he or she receives, but by comparing his or her benefits with those enjoyed by others.
Comparison provides a feeling of equity or inequity. There is a sense of equity when the employee’s
remuneration is equal or more than the remuneration received by others in the same category of jobs. If
the remuneration is lower, the employee feels he or she is inequitably treated. An employee sticks to an
organization when he or she is paid equitably. The organization’s pay structure must, therefore, be
equitable and consistent.
Employees get motivated to perform better when their past performance is rewarded adequately.
Employees set expectations about rewards and compensation to be received, if certain levels of performance
are achieved. These expectations determine goals or levels of performance for the future. Employees
achieving the desired level of performance expect a certain level of compensation. At some point, the
management evaluates and rewards the employee’s performance. Examples of such rewards include
merit-pay increases, promotions, and non-financial rewards such as recognition and increased status.
Employees consider the relationship between their performance and rewards related to that performance,
and then the fairness of the relationship. The final step in the process will have the employee setting new
goals and expectations, based on past experiences within the organization.
If employees see that hard work and superior performance are recognized and rewarded by the
organization, they will expect such relationships to continue in the future. Therefore, they will set higher
levels of performance for themselves, expecting higher levels of rewards. Of course, if employees see
little relationship between performance and rewards, then they may set minimum goals in order to retain
their jobs, but will not see the need to excel in their positions.
Remuneration is the only HR activity which has its impact on all other functions regarding personnel.
Take job evaluation, for example. It is job evaluation which establishes satisfactory wage and salary
differentials. As was stated above, competent people are attracted towards an organization if its remuneration
is attractive. Recruitment and selection are dependent upon wages and salaries offered to prospective
employees. There is a close relationship between performance appraisal and remuneration. This is
particularly true in cases where ‘payment by results’ schemes exist. Incentive payments depend on the
employee performance which needs to be carefully assessed. It needs no particular emphasis that
union-management relations largely depend upon employee remuneration. Industrial conflicts between
employees and employers take place on remuneration-related issues (see the Table below ). There are
other benefits of an effective remuneration system. Such a system, for example, helps the organization
obtain and retain employees at a reasonable cost. In the absence of a rational payment system, employees
are likely to be overpaid or underpaid. There are a number of labour acts which need to be complied with
by an organization. Non-compliance of any provision makes the organization guilty and punishable. A
properly designed wage and salary system helps the company avoid such possibilities.
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Table Percentage of Remuneration Related Issues to Total Disputes
Year Disputes Relating to wages, Allowances and Bonus Total Disputes

Percentage of Remuneration Related Issues to Total disputes

1985 506 1755 28.83
1986 633 1892 33.45
1987 619 1799 34.40
1988 590 1745 33.81
1989 533 1786 29.84
1990 514 1825 28.16
Finally, the primary goal of a wage policy in any country should be the promotion of economic
development. If economic development has been meagre and all-round development is stunted, one of the
reasons might well be the failure of the wage policy to contribute adequately to the process of economic
development.

17
 LESSON 2
PERFORMANCE EVALUATION
Dr. Neetu Jain
RDIAS
Institute of Management
Performance Evaluation or Performance Appraisal is the process of assessing the performance and
the progress of a employee or of a group of employees on a given job and his potential for future
development. According to Dale Yoder, “Performance appraisal includes all formal procedures used to
evaluate personalities and contributions and potentials of group members in a working organization. It
is a continuous process to secure information necessary for making correct and objective decisions on
employees.”
People differ in their abilities and aptitudes, which cannot be eliminated even with the same basic
education and training. There will be some difference in the quality and quantity of work done by
employees even on the same job. Thus it is necessary for the management to know these differences, so
that they are able to reward and rectify employees. The individual employee may also like to know the
level of his performance in comparison to others so that he may improve. So, there is a great need to
have suitable Performance Appraisal methods to measure the relative merit of each employee.
The basic purpose of performance appraisal (P.A) is to facilitate orderly determination of an employee’s
worth to the organization he is a part of. As performance appraisal is an important HRM function, it
provides important data on the performance of individual employee in relation to the organization.
Performance appraisal is considered to be the best development technique in the hands of the organization
aimed in improving its employees and their administrative abilities.
Performance appraisal means systematic evaluation of an employee’s personality and performance by
his supervisor, using various rating techniques. It is a formal program in an organization which is
concerned with not only the contributions of the employees but aims at spotting the potential also. It is
concerned with determining the differences among the employees working in the organization.
In many organizations - but not all - appraisal results are used, either directly or indirectly, to help
determine reward outcomes. That is, the appraisal results are used to identify the better performing
employees who should get the majority of available merit pay increases, bonuses, and promotions. By
the same token, appraisal results are used to identify the poorer performers who may require some form
of counseling, or in extreme cases, demotion, dismissal or decreases in pay.
Objectives of Performance Appraisal (P.A.)
1) Administrative Objectives
l Promotions
l Transfers
l Wage and salary administration
l Personnel research
l Training and development
2) Self Improvement Objective
l To bring out the deficiencies and shortcomings of employees and help them work on them.
Generally, the objectives of P.A are :
1. Helps in guiding and correction of employees.
2. Identify employee training needs and training programees can be made effective.
3. Document criteria used to allocate organizational rewards.
4. Form a basis for personnel decisions-salary (merit) increases, disciplinary actions, etc.

18
 5. Provide the opportunity for organizational diagnosis and development.
6. Facilitate communication between employee and administrator.
7. It also gives feedback to employees to improve their performance.
8. Helps the supervisors to evaluate the performance of employees periodically.
9. Ability of the staff is recognized and can be rewarded.
10. Provides incentive to the employees to better their performance.
The Performance Appraisal Process :
“Performance appraisal could thus be seen as an objective method of judging the relative worth or ability
of an individual employee in performing his task.”

THE PERFORMANCE APPRAISAL PROCESS

Establish performance standards.

Communicate Performance expectations to employees.

Measure actual performance.

Compare actual performance with standards.

Discuss the appraisal with employees.

Initiate corrective action (if necessary)

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 The performance management process starts with employee planning and ends with an evaluation of
employee progress. Managers and employees should meet to discuss planning and goals throughout the
year. The process, at its best, is a collaborative one which should add value for both the employee and
the employer.
The process involves the following steps:
1. Establishing Performance Standards: The appraisal process begins with the setting up of criteria to
be used for appraising the performance of employees. The criteria are specified with the help of job
analysis, which reveals the contents of a job. The criteria should be clear, objective and in writing. It
should be discussed with the supervisors to ensure that all the relevant factors have been included. The
criteria are clear when output can be measured. If work performance cannot be measured, the personal
characteristics, which contribute to employee performance, must be measured. These characteristics
include honesty, reliability, cooperation, team work, job knowledge, initiative, leadership, safety con-
sciousness, attendance, learning ability, adaptability, judgment, sense of responsibility, etc. These stan-
dards should be indicated on the Appraisal Form. Appraisal Forms should be carefully designed and
printed.
In addition, who is to do the appraisal and how frequently appraisal is to be done should also be
decided. In fact, performance standards will depend on the objectives of the appraisal, i.e. to appraise
actual performance on the present job or to judge potential for higher jobs.
The expectations a manager has in terms of work performance by his subordinates must be clear enough
in his mind so that he will be able to, at some later date, communicate these expectations to his
subordinates and appraise their performance against these previously established standards.
2. Communicating the Standards: The performance standards specified in the first step are communi-
cated and explained to the employees so that they come to know what is expected of them. . It should
not be part of the employee’s job to guess what is expected of them. Communication only takes place
when the transference of information has taken place and has been received and understood by the
subordinate.
The standards should be maintained. The reactions employees to the standards should be obtained.
If necessary the standards may be revised or modified in the light of feedback obtained from the employ-
ees and evaluators. Therefore, feedback is necessary from the subordinate to the manager. Satisfactory
feedback ensures that the information communicated by the manager has been received and understood
in the way it was intended.
3. Measuring Performance: Once the performance standards are specified and accepted, the next stage
is the measurement of actual performance. This requires choosing the right technique of measurement,
identifying the internal and external factors influencing the performance and collecting the information
on results achieved. Personal observations, written reports and face-to-face contacts are the means of
collecting the data on performance. The performance of different employees should be so measured that
it is comparable. What is measured is more important than how it is measured.And what we measure
determines, to a great extent, what people in the organization will attempt to excel at.
4. Comparing the Actual With the Standards: Actual performance is compared with the predeter-
mined performance standards. Such comparison will reveal the deviations, which may be positive or
negative. Positive deviations occur when the actual performance exceeds the standards. On the other
hand, excess of standard performance over the actual performance represents negative deviation.
5. Discussing the Appraisal: The results of the appraisal are communicated to and discussed with the
employees. Along with the deviations, the reasons behind them are also analyzed and discussed. Such
discussion will enable an employee know his weaknesses and strengths. Therefore, he will be motivated
to improve himself. The impression, the subordinate received about him has an impact on his subsequent
performance. The impact may be positive or negative depending how the appraisal feedback is presented
and discussed with the employee.

20
6. Taking Corrective Action: The final step in the appraisal is the initiation of corrective action when
necessary. Corrective action can be of two types. One is immediate and deals predominantly with symp-
toms. The other is basic and delves into causes. Immediate corrective action is often is described as
“putting out fires,” whereas basic corrective action gets to the source of deviation and seeks to adjust the
difference permanently. Through mutual discussions with employees, the steps required to improve per-
formance are identified and initiated. Training, coaching, counseling etc. are examples of corrective
actions that help to improve performance.This process can be shown in a diagram as below

Setting Performance Standards

Taking Corrective Actions Communicating Standards

Discussing Results
Measuring Performance

Comparing With Standards

Performance Appraisal Process

21
Traditional Methods of Performance Appraisal
There are various methods of performance appraisal which may be classified into two categories:
(i) Traditional Methods
(ii) Modern Methods
Traditional Methods
Traditional methods are old techniques of performance appraisal. They are based on trait- oriented
appraisal. Evaluation of employees is done on the basis of standards of personal traits or qualities such
as:
l Attitudes
l Judgments
l Versatility
l Initiative
l Dependability
l Leadership
l Loyalty
l Punctuality
l Knowledge of job etc.
Following are the traditional methods of appraisal : -
1. Confidential Report
2. Free form or essay
3. Straight Ranking
4. Paired Comparison
5. Forced distribution
6. Graphic Rating Scale
7. Checklist Method
8. Critical Incidents
9. Group Appraisal
10. Field Review
1. Confidential Report
This is a traditional form of appraisal used in most government organizations. A confidential report
is prepared by the employee’s immediate superior. It covers the strengths and weaknesses ,main
achievements and failure, personality and behavior of employees. It is descriptive appraisal used for
promotion and transfers of employees. But it involves lot of subjectivity because appraisal is based on
impressions rather than on data.. No feedback is provided to the employee being appraised. Therefore,
its credibility is very low. The method focuses on evaluating rather than developing the employee. The
employee who is appraised never knows his weaknesses and the opportunities available for overcoming
them.
2. Free Form or Essay Appraisal
Probably the simplest method of appraisal is to have the rater write a narrative describing an employee’s
strengths, weaknesses, past performance, potential, and suggestions for improvement. The essay method
of performance appraisal requires the appraiser to prepare a written statement about employees being
appraised. The essay describes specific strengths and weaknesses in job performance. Further, the essay

22
may suggest actions the employee might take in order to remedy problem areas identified in the appraisal.
The essay may be written by the appraiser alone, or it be prepared with input from the employee. While
the rating scale is structured and confining, the narrative essay allows the appraiser to examine any
relevant issue, attribute, or performance. Thus, appraisers are able to place emphasis on whatever issues
or attributes they feel are appropriate. In this sense, the narrative essay is open-ended and flexible.
For example, the narrative essay may indicate that the incumbent’s job description needs revision.
Further, additional comments in the essay may pertain to the conditions and circumstances of effective/
ineffective employee behaviour. The narrative essay is also flexible enough to permit comments from the
employee.
The strength of the essay appraisal lies in its simplicity. It requires no complex forms or extensive
training to complete. But its weaknesses are many. Because the essays are unstructured, they are likely
to vary widely in terms of length and content. This makes it difficult to compare individuals across the
organization. And of course some raters are better writers than others. So a “good” or “bad” evaluation
may be determined as much by the rater’s writing skill as by the employee’s actual level of performance.
However, the essay appraisal can provide considerable information, much of which can easily be fed back
and assimilated by the employee.
On the other hand, the essay method is time-consuming and more difficult to administer. Generally,
appraisers find the narrative essay more demanding than methods such as rating scales. Furthermore, the
greatest advantage - freedom of expression - is also a disadvantage. For example, different writing skills
of appraisers can distort the process. Since the process is subjective (and, in general, we’re striving for
objectivity in evaluation), it is difficult to compare the results of different employees.
3. Straight Ranking Method
Ranking is a simple process of placing employees in a rank according to their job performance. It
permits comparison of all employees in any single rating group regardless of the type of work. All
workers are judged on the same factors and they are rated on the overall basis with reference to their job
performance instead of individual assessment of traits. In this way, the best is placed first in the rank and
the poorest occupies the last rank. The difficulty of this system is that the rater is asked to consider a
whole person. Subjectivity of the appraiser may enter into his judgements. The subjectiveness in this
method can be reduced by asking the appraiser to rank employees on certain desirable traits. The other
difficulty with this method is that it does not indicate the degree of difference between the first man and
the second man and so on.
4. Paired Comparison
Paired comparison is an improvement over simple ranking. Under this, every employee in a job
family is compared with every other employee to determine which is the better worker. The rater is
provided with a little booklet containing two names on each page. Obviously the number of rank order
would be n( n -1) /2, where n is the total number of persons to be compared. In this way, every employee
is compared with the every other employee in the same job family. The paired comparison gives a more
reliable rating than the order of ranks discussed above although this system is more tedious to construct
and use. It cannot be used for periodic employees’ ratings as it does not make evaluation of any improvement
in the employees that might have been made over a period of time.
5. Graphic Rating Scale
One of the most popular methods of appraisal is the graphic rating scale. Graphic rating scales can
be used to assess factors such as quantity and quality of work, job knowledge, cooperation, loyalty,
dependability, attendance, honesty, integrity, attitudes, and initiative. However, this method is most valid
when abstract traits like loyalty ‘or integrity are avoided unless they can be defined in more specific
behavioral terms. The assessor notes down the list of factors and notes that point along the scale or
continuum that best describes the employee. There are typically five to ten points on the continuum. In

23
the design of the graphic scale, the challenge is to ensure that both the factors evaluated and the scale
points are clearly understood and unambiguous to the rater. As ambiguity occur, bias is introduced.
As indicated above, formal appraisal systems are necessary in order to introduce objectivity into the
evaluation process. Rating scales provide appraisers a fairly high degree of structure. Using rating scales,
employee traits and characteristics are rated on a scale that usually has several points ranging from “poor”
to “excellent”. For example, characteristics assessed might include cooperation, communications ability,
initiative, punctuality and technical competence. It is, of course, important that the traits being evaluated
be job-related. In designing the scale, the human resource specialist must make reference to the appropriate
job descriptions. The greatest advantage of rating scales is that they are structured and standardized.
Thus, ratings can be easily compared and contrasted. Using rating scales, each employee is rated according
to the same basic appraisal process. The process encourages equality in treatment for all employees.
Further, rating scales are easy to construct, to use and to understand.
Even though rating scales ought to be constructed with reference to the relevant job descriptions,
questions must be asked about whether or not the selected traits are relevant to the jobs of all the
appraisees? Often, when efforts are made to standardize an appraisal form across the entire organization,
certain traits that are included will have a greater relevance for some jobs than others. For example, the
trait “initiative” might not be very important in a job that is tightly defined and rigidly structured. In such
cases, a low appraisal rating for initiative may not mean that an employee lacks initiative. Rather, it may
reflect that fact that an employee has few opportunities to use and display that particular trait.
In efforts to standardize the rating instrument, it is possible that factors that an employee’s performance
may depend on, have not been included in the selected list of relevant traits. Thus, some employees may
end up with ratings that do not fairly reflect their effort or value to the organization.
Selective perception is the human tendency. Although rating scales are designed to lend objectivity
and empiricism to the evaluation process, it is difficult to eliminate problems of selective perception
(biases and rater inconsistencies). Similarly, the reliability of rating instruments may be questioned if
different appraisers would interpret the rating traits (such as, “punctuality”) differently. What exactly does
“Below average skill” mean? Different appraisers could very likely interpret this “score” differently.
Using a rating scale, the rater provides a subjective evaluation of an employee’s performance along
a scale from high to low. Since the method provides a numerical value for each dimension or trait, an
overall average can be calculated for each employee. The rating scale is inexpensive and easy to administer.
Rating Scale Example

5 4 3 2 1
Excellent Good Acceptable Fair Poor
1. Dependability
2. Initiative
3. Overall Output
4. Attendance
5. Attitude
6. Cooperation
7. Quality of work
etc.

24
6. Forced Distribution Method
Some appraisers suffer from a constant error, i.e., they either rate all workers as excellent, average
or poor. They fail to evaluate the poor, average or excellent employees clearly. The forced distribution
system is devised to force the appraiser to fit the employees being appraised into predetermined ranges
of scale. It has an advantage over the paired comparison system in that two or more employees can be
given equal ratings. This system is based on the presumption that employees can be divided into five
points scale of outstanding, above average, average, below average and poor. In this system, the appraiser
is asked to distribute the employees into these categories in such a way that about 10% of the men are
in group ‘outstanding ‘, 20% ‘above average’, 40% ‘average’ ; 20% ‘below average’, and 10% ‘poor’.
This method obviously eliminates the room for subjective judgement on the part of supervisors.
Besides this, the system is easy to understand and administer.The objective of this technique is to spread
out ratings in the form of a normal distribution which is open to criticism. Many times, this categorization
is not found in workgroups particularly when the size of the group is comparatively smaller. As a matter
of fact, forced distribution of rankings is feasible for a large group.
7. Checklist
The checklist is another example of a rating-type performance appraisal methodology. This rating
method requires the rater to select statements or words that describe the employee’s performance or
characteristics.In the checklist, the evaluator uses a list of behavioral descriptions and checks off those
behaviors that apply to the employee. The evaluator merely goes down the list and gives “yes” or “no”
responses. Following is an example of checklist:-
Sample of Checklist Items for Appraising Salesclerks
Yes No
1. Are “Supervisor’s orders usually followed? ___ ___
2. Does the individual approach customers promptly? ___ ___
3. Does the individual suggest additional merchandise to customers? ___ ___
4. Does the individual keep busy when not servicing a customer? ___ ___
5. Does the individual lose his or her temper in public? ___ ___
6. Does the individual volunteer to help other employees? ___ ___
Once the checklist is complete, the staff personnel department, not the manager doing the checklist,
usually evaluates it. Therefore, the rater does not actually evaluate the employee’s performance; or she
merely records it. An analyst in the personnel department then scores the checklist, often weighting the
factors in relationship to their importance. The final evaluation can then be returned to the rating manager
for discussion with the subordinate, or someone personnel department can provide the feedback to the
subordinate. The checklist reduces some bias, since the rater and the scorer are different, but the rater
can usually pick up the positive and negative implications in each item so bias can still be introduced.
From a cost standpoint, this appraisal method may be inefficient if there are a number of job categories
because a checklist of items must be prepared for each category.
8. Critical Incident Method
Using the Critical Incident Technique as an appraisal methodology, the rater is required to record
statements that describe extremely good and bad employee behavior related to performance - CRITICAL
INCIDENTS. The recorded incidents include a brief explanation of what happened. Since real incidents
are recorded, this method is particularly useful giving employees job-related feedback.
Critical incident appraisal focuses the rater’s attention on those critical or key behaviors that make
the difference between doing a job effectively and doing it ineffectively. What the appraiser does is write
down little anecdotes that describe what the employee did that was especially effective or ineffective. For
example, the college dean might write the following critical incident about one of her instructors:

25
“Outlined the day’s lecture on the chalkboard at the beginning of class.” This approach to appraisal,
specific behaviors are cited, not vaguely defined personality traits.
The strength of the critical incident method is that it looks behavior of employees. Additionally, a
list of critical incidents on a given employee provides a rich set of examples from which the employee
can be shown which of his or her behaviors are desirable and which ones call for improvement. Its
drawbacks are basically that
(1) Appraisers required to regularly write these incidents down, but doing a daily or even weekly
basis for all of their subordinates is time-consuming and burdensome for managers;
(2) Critical incidents suffer from the same comparison problem found in essays; mainly, .do not lend
them to quantification. Therefore the comparison and ranking of subordinates is difficult.
9. Field Review Method
Under this method, an expert from personnel department interviews the supervisors .The interviewer
questions the supervisor about the requirements of his unit and about the performance of each man in
his job. Thus, there is form with factors or degrees, but overall ratings are obtained. The workers are
classified into three categories as outstanding, satisfactory and unsatisfactory.
He probes to find not only how a man is doing but also why he does that way and what can be done
to improve or develop him. The supervisor is required to give his opinion about progress of his subordinates,
the level of the performance of each subordinates weaknesses, good points, outstanding ability,
promotability, and the possible action in cases requiring further consideration. The questions are asked
verbally.
The success of field review method depends upon the competence of interviewer. If he knows his job,
he can contribute significantly to accurate appraisal. Field review method relieves the supervisors of the
tedious writing work of appraisal forms.
10. Group Appraisal Method
In this method, a group will appraise the performance of employee. The group include immediate
boss, Supervisor, Head of Department, Manager of Personnel department & other supervisor who is in
close contact with employee. These people will determine the standards of performance. The major
advantage of this method is that personal bias can be reduced to a great extent because many people are
involved in the appraisal process
Criticism of Traditional Methods
Traditional methods are too subjective in nature because all of them are based on personal judgment
of the rater. The personal judgment is always subjected to personal bias or prejudice as well as pressure
from certain other areas. The appraiser may not be able to judge the competence of the employees
because of lack of training.
Modern Methods of Performance Appraisal
Performance appraisal may be defined as a structured formal interaction between a subordinate and
supervisor, that usually takes the form of a periodic interview (annual or semi-annual), in which the work
performance of the subordinate is examined and discussed, with a view to identifying weaknesses and
strengths as well as opportunities for improvement and skills development.
In many organizations - but not all - appraisal results are used, either directly or indirectly, to help
determine reward outcomes. That is, the appraisal results are used to identify the better performing
employees who should get the majority of available merit pay increases, bonuses, and promotions. By
the same token, appraisal results are used to identify the poorer performers who may require some form
of counseling, or in extreme cases, demotion, dismissal or decreases in pay. (Organizations need to be
aware of laws in their country that might restrict their capacity to dismiss employees or decrease pay.)
Whether this is an appropriate use of performance appraisal - the assignment and justification of
rewards and penalties - is a very uncertain and contentious matter.
26
 There are four important methods of performance appraisal, which are used by the modern concerns.
The first method is Human Resource Accounting which evaluates the costs and contribution of an
employee. The second is Management by Objectives which represents results-oriented appraisal. The
third method is Behaviourally-Anchored Rating Scale, which is based on rating the behaviour of the
subordinates. Lastly, assessment centre method is used by big companies to judge the potential of
employees.
1. Human Resource Accounting
Accounting for the human resources deals with the measurement of costs, which are associated with
recruiting, selecting, training, placing and developing the employee of an organisation. This also involves
measuring the present economic value of human resources to an organization. Human Resources Accounting
(HRA) may thus be reckoned as the measurement and reporting of the cost and value of the people as
organisational resources.
The basic objective underlying HRA is to facilitate the effective and efficient management of human
resources as it would provide the manager with the information needed to acquire, develop, allocate,
conserve, utilize, evaluate and reward human resources. Besides, HRA also provides feedback to a
manager of his own performance.
Human Resource Accounting is intended primarily to be used as a managerial tool. It also has
significant use for present and potential investors and other users of corporate financial statements who
would be interested to know the value of the firm’s human assets. It also provides the organisation with
a more accurate accounting of its return on the total resources employed.
Benefits of Human Resource Accounting
In the field of managerial decision-making, HRA would help in making choices between various
types of investments in human resources and other assets. It would assist the manager particularly with
regard to:
(a) Direct recruitment vs. promotion.
(b) Transfer vs. retention.
(c) Retrenchment or relieving vs. retention.
(d) Utility of cost reduction program in view of its possible impact on human relations.
(e) Impact of budgetary control on human relations and organisational behaviour.
(f) New dimension added to capital budgeting process, which includes human resource investment
costs.
(g) Consideration of an adequate return on investment in human assets and also a more useful
interpretation of return on capital employed.
2. Management by Objectives
It was Peter Drucker who proposed goal-setting approach to performance appraisal, which he called
‘Management by Objectives and Self Control’. This approach was further strengthened by Douglas
McGregor. McGregor was concerned with the fact that most traditional appraisal systems involved
ratings of traits and personal qualities that he felt were highly unreliable. Besides, the use of such trait
ratings produced two main difficulties:
(I) The manager was uncomfortable about using them and resisted making appraisals,
(II) It had a damaging effect on the motivation and development of the subordinate.
Goal setting approach or “management by objectives” (MBO) is the same as behavioural approach
to subordinate appraisal, actually called “work planning and review” in case of General Electric Co.,
U.S.A. Under this approach, an employee is not appraised by his recognizable traits, but by his performance
with respect to the agreed goals and objectives. Thus, the essential feature of this approach is mutual

27
establishment of job goals. The application of goal setting approach to performance appraisal involves
following steps:
I. The subordinate discusses his job descriptions with his superior and they agree on the contents
of his job and the key results areas.
2. The subordinate prepares a list of reasonable objectives for the coming period of six to twelve
months.
3. He sits with his’ superior to discuss these targets and plans, and a final set is worked out.
4. Check-points are established for the evaluation of progress, and the ways of measuring progress
are selected
5. The superior and the subordinate meet at the end of the period to discuss the results of the
subordinate’s efforts to meet the targets mutually established.
The goal setting approach is based on clear and time bound objectives from the corporate level to
the operative level. This approach can be applied with great success if the Performance appraisal program
consists of the following elements: (i) Good job descriptions are available to help setting of goals for
different positions.
(ii) Superiors have trust in the subordinates to establish reasonable goals; and
(iii) There is emphasis on problem solving rather than criticism of the performance of the subordinates.
The goal setting approach has done away with the judgmental role of the superiors in the appraisal
of their subordinates. It has led to greater satisfaction, greater agreement, greater comfort and less tension
and hostility between the workers and the management. This approach is considerably superior to the
traditional approach performance appraisal. It emphasizes training and development of individuals. It is
problem-solving approach rather than tell and sell approach. This approach has also got a built-in device
of self-appraisal by the subordinates because they know their goals and the standards by which their
performance will be measured.
The goals setting approach suffers from the following limitations:
(i) This approach is not easy to administer. It involves considerable time, thought and contact
between the superior and the subordinate. If the span of supervision is quite large, it will not be
possible for the superior to have discussion with each and every subordinate for setting up
mutually agreed goals.
ii) This approach is appropriate for the appraisal of executives and supervisory personnel who can
understand it in a better way. Operative workers cannot understand this approach and moreover,
a vast majority of them do not want to take initiative in setting their own goals.
iii) Sometimes supervisors set very high goals for their subordinates just to please their bosses.
iv) Workers are not interested in it, because it involves lot of paper work
3. Behaviourally anchored rating scales
Behaviourally anchored rating scales (BARS) are designed to identify the critical areas of performance
for a job, and to describe the more effective and less effective job behaviour for getting results. Performance
is evaluated by asking the rater to record specific observable job behaviours of an employee and then to
compare these observations with a “behaviorally anchored rating scale”. As a result, the supervisor is in
a position to compare the employee’s actual behaviour with the behaviour been previously determined
to be more or less effective.
Behaviourally Anchored Rating Scales (BARS) approach combines elements of the Graphic rating
scales and critical incident method. Using BARS, job behaviours from critical incidents - effective and
ineffective behaviours - are described more objectively. This method employs individuals who are familiar
with a particular job to identify its major components. They are asked to rank and validate specific

28
behaviours for each of the components. BARS approach gets away from measuring subjective personal
traits and instead measures observable, critical behaviours that are related to specific job dimensions.
Steps involved in developing BARS are as follows:
I. Identification of Critical Incidents or Behaviours: People with knowledge of the job to be probed such
as job holders and supervisors describe specific examples of effective and ineffective behaviour related
to job performance.
2. Identification of Performance Dimensions: People are assigned the task of developing the instrument
cluster pertaining to the incidents into a small set of key performance dimensions. Generally, between
five and ten dimensions account for most of the performance. Examples of performance dimensions
include technical competence, relationships with customers, handling of paperwork and meeting day-to-
day deadlines. While developing varying levels of performance for each dimension (anchor), specific
examples of behaviour should be used which could later be scaled in terms of good, average or below
average performance.
3. Reclassification of Critical Behaviours: Another group of people who are knowledgeable about the
job is instructed to retranslate or reclassify the critical incidents generated under the previous step. They
are given the definition of job dimension and total to assign each critical incident to the dimension that
it best describes. At this stage, incidents for which there is less than 75 per cent agreement are discarded
as being too subjective.
4. Assigning Scale Values to the Critical Behaviours: Each incident is rated on a one-to-nine scale with
respect to how well it represents performance on the appropriate dimension. A rating of one represents
ineffective performance; the top scale values indicate very effective performance. The second group of
participants usually assigns the scale values. Means and standard deviations are then calculated for the
scale values assigned to each incident. Typically, incidents that have standard deviations of 1.50 or less
(on a 7-point scale) are retained.
5. Development of Bar Instrument: About six or seven incidents for each performance dimension - all
having met both the retranslation and standard deviation criteria - are used as behavioural anchors. The
final BARS instrument consists of a series of vertical scales (one for each dimension) anchored (or
measured) by the final incidents. Each incident is positioned on the scale according to its mean value.
For example, for appraising the performance of grocer clerk, called checker, in a large grocery chain
store eight anchors of job performance can be included namely, (I) knowledge and (2) conscientiousness,
(3) skills in human relations, (4) skill in operation of register. (5) Skill in bagging, (6) organizational
ability of check-stand work, (7) skill in monetary transactions, and (8) observational ability.
4. Assessment Centre
An assessment centre is a special unit created to evaluate the performance of employees and also
assess their training and development needs. It is staffed by experienced managers with expertise in
performance evaluation. The evaluators observe the employees as they perform jobs. Assessments are
done generally to determine employee potential for promotion. The evaluators prepare a summary report
and feedback is administered on a face-to-face basis to the employees who ask for it.
An assessment centre generally measures interpersonal skills, communicating abiIity, ability to plan
and organize, etc. Personal interviews and projective tests are used to assess work motivation, career-
orientation and dependence on others. Paper and pencil tests are used to measure intellectual capacity.
The salient features of the assessment centre method are as follows:
i) Evaluators are drawn from experienced managers with proven ability at different levels of
management.
ii) The assessment centre method uses simulation exercises such as in-basket exercise, business
games, role-playing incident and leaderless group discussion, structured interview, etc.

29
 iii) The evaluators appraise all candidates, both individually and collectively, and each candidate is
given one of the four categories; more than acceptable, acceptable, less than acceptable and
unacceptable.
iv) A summary report is prepared by the evaluators, and a feedback on a face-to-face basis is
administered to the candidates who ask for it.
Assessment centres are used for three purposes, namely, (i) to evaluate the performance and Potential
of employees, (ii) to determine the training and development needs of employees, and (iii) to provide
useful information for human resource planning. They can also be used for the selection of students for
entry level positions in the organizations. The advantages of the assessment centre technique are as
under:-
i) It uses a variety of techniques and standardized ways of interpreting behaviour of candidates.
ii) It pools judgment of several assessors and thus minimizes scope of bias.
iii) The performance ratings can be used for promotion and career development decisions.
iv) The performance ratings can be used in counselling the candidates.
Assessment centre method has some limitations also. Appraisal through this method is time consuming
and expensive. Further the candidates who receive negative reports from the assessment centre may feel
demoralised. In order to make this method effective, it is necessary to state the purpose of appraisal
clearly, to have clear job descriptions, to train the assessors, and to periodically evaluate and revise the
assessment program.
Errors Involved in The Process of Performance Appraisal
Because of the judgmental role of the superiors under the traditional systems, performance ratings
are frequently subject to a number of errors and weaknesses like Halo Error, Central Tendency,
Leniency or Strictness, Recent Behavior Bias and some Miscellaneous Biases.
1. Halo Effect
The halo effect is the tendency to rate someone high or low in all categories because he or she is
high or low in one or two areas. This type of error occurs when the rater allows one aspect of man’s
character or performance to influence his entire evaluation. It is the tendency of many raters to let the
rating they assign to one characteristic excessively influence their ratings on all subsequent characteristics.
Evaluating someone lower is sometimes also called the “devil effect”.
2. Central Tendency
The habit of assessing almost everyone as average. A person applying this bias will tend not to rate
anyone very high or very low. This error occurs when the rater is in doubt about the subordinates or has
inadequate information about them or is giving less attention and effort to the rating process. Because
of these reasons generally the raters are reluctant to rate people at the outer ends of the scale. If the rater
is unfamiliar with some of the subordinates or does not have sufficient time to devote to the rating
process, he may play it safe by neither condemning nor- praising.
3. Recency Bias
Tendency to assess people based on most recent behavior and ignoring behavior that is “older”. Some
employees being aware of this tendency show better results when they feel that they are being observed
and the report of their performance is to be compiled soon.
4. Constant Error:
It includes following two types of errors:
A. Leniency Bias
Tendency to rate higher than is warranted, usually accompanied by some rationalization as to why
this is appropriate. Lenient or easy raters assign consistently high values or scores to their subordinates

30
B. Strictness Error
Strict or harsh raters give consistently low ratings.
5. False Attribution Errors
We have a tendency to attribute success or failure to individual effort and ability (at least in North
America). So when someone does well, we give them credit, and when someone does less well, we
suggest it’s somehow their fault. While there is some truth in this, the reality is that performance is a
function of both the individual and the system he or she works in. Often we misattribute success and
failure and assume they are both under the complete control of the employee. If we do, we will never
improve performance.
6. Miscellaneous Biases
In many cases, raters may give higher ratings because he thinks that it would look bad for him if
employees in other department received higher pay increases than his group.
Common Performance Appraisal Errors

Errors Description Example

Contrast Effect Tendency of a rater to evaluate
people in comparison with other
individuals rather than against the
standards for the job
Think of the most attractive person
you know and rate this person on a
scale of 1 to 10. Now think of your
favorite glamorous movie star. Rerate
your acquaintance. If you rated your
friend lower the second time, contrast
effect is at work.

First impression Tendency of a rater to make an A new supervisor noticed an employee

error initial positive or negative
judgment of an employee and allow
that first impression to color or
distort later information
who was going through a divorce
performing poorly. Within a month the
employee’s performance returned to its
previous high level, but the
supervisor’s opinion of the individual’s
performance was affected by the initial
negative impression.

Halo/horns Inappropriate generalizations from George’s outstanding writing ability

effect one aspect of an individual’s caused his supervisor to rate him
performance to all areas of that highly in unrelated areas where his
person’s performance performance was actually mediocre.

Similar-to-me The tendency of individuals to rate
effect people who resemble themselves
more highly than they rate others
Carol was a single mother with four
children and was promoted to
supervisor. Unknowingly she rated
several other women who were also
single mothers higher than their
performance warranted.

31
Central The inclination to rate people in
tendency the middle scale even when their
performance clearly warrants a
substantially higher or lower rating
Negative and The opposite of central tendency:
positive skew the rating of all individuals as
higher or lower than their
performance warrants
Attribution bias The tendency to attribute
performance failings to factors
under the control of the individual
and performance successes to
external causes
Recency effect The tendency of minor events that
have happened recently to have
more influence on the rating than
major events of many months ago
Stereotyping The tendency to generalize across
groups and ignore individual
differences
32
Because Harold had a concern that he
would not be able to deal with
confrontation during an appraisal
session, he rated all of his employees
as “Meets Expectations.”
Susan rates all of her employees higher
than she feels they actually deserve,
in the hope that this will cause them
to live up to the high rating. While
Carl sets impossibly high standards
and is proud of never having met an
employee who deserved a superior
rating.
Harriet, attributes the successes of her
work group to the quality of her
leadership and the failings to their bad
attitudes and inherent laziness.
Victorial kept no records of critical
incidents. When she began writing the
appraisals for her employees she
discovered that she could only recall
examples of either positive or
negatives performance for the last two
months.
Waldo was quiet and reserved,
however, he is well liked and respected
by both internal and external
customers. His boss rated him lower
than the other customer service
personnel since he didn’t “fit the
mold.”
 LESSON 3

JOB EVALUATION
Dr. Neetu Jain
RDIAS
Institute of Management
Meaning of job evaluation:
Job evaluation is an orderly and systematic technique of determining the relative worth of the various
job within the organization so as to develop an equitable wage and salary structure.
British Institute of Management has defined the job evaluation as “the process of analysis and assessment
of jobs to ascertain reliably their relative worth using the assessment as the basis for a balanced wage
structure”
Job evaluation is a practical technique, designed to enable trained and experienced staff to judge the
size of one job relative to others. It does not directly determine pay levels, but will establish the basis
for an internal ranking of jobs. It is the evaluation or ratings of jobs to determine their position in a job
hierarchy. It is a systematic procedure for determining relative worth of job. Once the worth of job has
been determined it becomes easier to fix the wage structure that will be fair and equitable.
International Labor Organization defines Job Evaluation as “ An attempt to determine and compare
the demands which the normal performance of particular jobs make on normal workers without taking
into account of the individual abilities or performance of the workers concerned.”
Organizations usually begin the process of designing a wage structure by determining their job
structure. Two often-cited principles of compensation are (1) equal pay for equal work and (2) more pay
for more important work. Both imply that organizations pay employees for contributions required by
jobs.Most organizations utilize job assignment as a major determinant of employee contributions. A
formal wage structure, defined as a rate or range of rates established for job classifications, seems to be
standard organization practice, except in very small organizations. Formal job evaluation or informal
comparison of job content is the almost universal base of pay rates.
Job evaluation is the process of methodically establishing a structure of jobs within an organization
based on a systematic consideration of job content and requirements. The purpose of the job structure
or hierarchy is to provide a basis for the pay structure. Job evaluation is concerned with jobs, not people.
A job is a grouping of work tasks. It is an arbitrary concept requiring careful definition in the organization.
Job evaluation determines the relative position of the job in the organization hierarchy. It is assumed that
as long as job content remains unchanged, it may be performed by individuals of varying ability and
proficiency.
Job evaluation is a process of analysis and describing position, grouping them and determining their
relative value by comparing the duties of different positions in terms of their different responsibilities and
other requirements.
It does not set the price of the job but fixes its relative worth, which then helps in setting the wages.
Again here we must understand this very clearly that rating the job does not mean rating the person
performing the task.
Objectives of Job Evaluation
1. To determine the equitable wage differentials between the different job in the organization.
2. To eliminate the wage inequities.
3. To establish a rational basis for incentive, wage structure and bonus schemes.
4. To develop a consistent wage policy.
5. To provide a framework for periodic review and revision of wage rates.
6. To provide a basis for wage negotiations with trade unions by providing information.
7. To minimize the wage discrimination on the basis of the age, sex, caste, region, religion, etc
8. To enable the management to gauge and control the pay roll cost.
33
Principles of Job Evaluation
1. All jobs in an organisation will be evaluated using an agreed job evaluation scheme.
2. Job evaluators will need to gain a thorough understanding of the job
3. Job evaluation is concerned with jobs, not people. It is not the person that is being evaluated.
4. The job is assessed as if it were being carried out in a fully competent and acceptable manner.
5. Job evaluation is based on judgement and is not scientific. However if applied correctly it can
enable objective judgements to be made.
6. It is possible to make a judgement about a job’s contribution relative to other jobs in an organisation.
7. The real test of the evaluation results is their acceptability to all participants.
8. Job evaluation can aid organisational problem solving as it highlights duplication of tasks and
gaps between jobs and functions.
9. Clearly defined and identifiable jobs must exist. These jobs will be accurately described in an
agreed job description.
Advantage of Job Evaluation
1. Job evaluation is a logical and objective technique of ranking jobs and thereby removing wage
inequities. It is helpful in developing an equitable, rational and consistent wage and salary
structure.
2. It helps to improve the industrial relation by reducing employee doubts and grievances arising
out of wages. It increases employee satisfaction on wage differentials.
3. It helps in fitting new jobs at their appropriate places in the existing wage structure.
4. It provides a clear and objective basis for wage negotiations and collective bargaining.
5. It simplifies wage administration by making wage rates more uniform.
6. It facilitates job redesign by reallocating the easy and difficult tasks equally among different jobs.
7. It reveals jobs which require less of more skilled workers than those already performing these
jobs. In this way job evaluation facilitates better utilization of the workforce.
The Job Evaluation Process
The first step is a study of the jobs in the organization. Through job analysis, information on job
content is obtained, together with an appreciation of worker requirements for successful performance of
the job. This information is recorded in the precise, consistent language of a job description.The next step
is deciding what the organization “is paying for” — that is, what factor or factors place one job at a
higher level in the job hierarchy than another. These compensable factors are the yardsticks used to
determine the relative position of jobs. In a sense, choosing compensable factors is the heart of job
evaluation. Not only do these factors place jobs in the organization’s job hierarchy, but they also serve
to inform job incumbents which contributions are rewarded.
The third step in job evaluation is to select a method of appraising the organization’s jobs according
to the factor(s) chosen. The method should permit consistent placement of jobs containing more of the
factors higher in the job hierarchy than jobs involving lesser amounts.
The fourth step is comparing jobs to develop a job structure. This involves choosing and assigning
decision makers, reaching and recording decisions, and setting up the job hierarchy.
The final step is pricing the job structure to arrive at a wage structure.
This view of job evaluation implies that its major purpose is to classify jobs and establish a job
hierarchy based on job content. Other perspectives are that job evaluation (1) links external and internal
34
markets, and (2) is a process used to gain consensus and acceptance of a pay structure. Perhaps these
views could all be accommodated by the recognition that job structures and wage structures are separate
concepts and that the relationship between them is a decision that varies among organizations.
Methods of Job Evaluation
Job evaluation can involve different techniques and the needs of the organisation will often determine
which is most appropriate method. However, it should be borne in mind that only an analytical scheme,
such as points rating, is likely to provide a successful defence to an equal pay for work of equal value
claim.
There are several methods of job evaluation . These methods can be divided into two parts:
Job Evaluation Methods

Non- Quantitative Methods Quantitative Methods

Ranking or Job comparison Point Rating

Grading or Job classification Factor Comparison

Non Quantitative methods

Non Quantitative methods of Job evaluation are as follows:
a) Ranking Method:
It is the simplest of all methods as it is simple to administer. A committee of several executives is
constituted which evaluates the job description and ranks them in order of importance beginning with the
most important job to the least important job in the organization. No specific factors are used for
consideration. The main purpose of using this method is to determine whether the job involves the same
amount of responsibility, duties, requirements as other in the series or a higher or a lower level than they
do. In this method jobs are not split up in their basic component instead the whole job is compared. Jobs
are compared to each other based on the overall worth of the job to the organization. The ‘worth’ of a
job is usually based on judgments of skill, effort (physical and mental), responsibility (supervisory and
fiscal), and working conditions.
There are several steps in the job ranking method.
1. Obtain job information. Job analysis is the first step: Job descriptions for each job are
prepared, and the information they contain about the job’s duties is usually the basis for ranking
jobs. (Sometimes job specifications are also prepared. However, the ranking method usually
ranks jobs according to the whole job, rather then a number of compensable factors. Therefore,
job specification which list the job’s demands in terms of problem solving, decision making, and
skills, for instance- are not as necessary with this method as they are for other job evaluation
methods.)
2. Select and group jobs. It is often not practical to make a single ranking for all jobs in an
organization. The usual procedure is to rank jobs by department or in clusters (such as factory
workers or clerical workers). This eliminates the need for direct comparison of, factory jobs and
clerical jobs.
3. Select compensable factors. In the ranking method, it is common to use just one factor (such
as job difficulty) and to rank jobs based on the whole job. Regardless of the number of factors
you choose, it’s advisable to explain the definition of the factor(s) to the evaluators carefully so
that they evaluate the jobs consistently.
35
 4. Rank jobs. For example, give each rater a set of index cards, each of which contains a brief
description of a job. Then they rank these cards from lowest to highest, some managers use an
“alternation ranking method” for making the procedure more accurate. Here you take the cards,
first choosing the highest and the lowest, cards. Table 11-3 illustrates a job ranking. Jobs ranking.
Jobs in this small health facility are right. After ranking, it is possible to slot additional jobs
between those already ranked and to assign an appropriate wage rate.
5. Combine ratings. Usually, several raters rank the jobs independently. Then the rating committee
(or the employer) can simply average the rankings.
This is simplest job evaluation method, as well as the easiest to explain. And it usually takes less time
than other methods.
Some of sits drawbacks derive more from how it’s used then from the method itself. For example,
there’s a tendency to rely too heavily on “guesstimates.” Similarly, ranking provides no yardstick for
quantifying the value of one job relative to another.
For example, job number 4 may in fact be five times “more valuable” than job number 5 , but with
usually more appropriate for small organizations that can’t afford the time or expense of developing a
more elaborate system.
Three methods are used in ranking methods:
1) Utilizing Job Description: In this each rater is given a set of job descriptions, one for each job
to be ranked. The job descriptions are then studied and analyzed. The difference between them
is noted with respect to the key points selected. The jobs are then ranked depending on the
amount of characteristics they require. After each rater has assigned his rankings independently,
their rankings can be compared and majority rankings are selected.
2) Paired Comparison method: In this each job is paired with every other job in the series. Next,
the rater examines each pair and determines which of the two is more difficult in terms of
characteristics selected as guides. He then underlines the more difficult job. The number of times
a particular job is rated more difficult than the other is counted.
3) Ranking along number line: It is an extension of job description and paired comparison method.
Here ranks obtained from job descriptions or paired comparison is spaced along the number
line.Each job is then placed along the line on the basis of its closeness to the highest ranked job.
Merit
I. It is the most simple of methods employed since the raters are fully familiar with the job and
workers also understand the implementation of the process.
II. It is very effective when only few jobs are to be evaluated( less than 30)
Demerit
I. Difficult to administer as the number of jobs increases.
II. Ranking of jobs need to be repeated each time the new job enters the organization.
III.Rank judgments are subjective.
IV. Since there is no standard used for comparison, new jobs would have to be compared with the
existing jobs to determine its appropriate rank. In essence, the ranking process would have to be
repeated each time a new job is added to the organization.
b) Job Grading or Classification Method:
This method is considered as an improvement over the ranking method. It involves following steps:
1) Establishment of Job class or Grade.
2) Definition of each grade.
3) Classification of individual jobs according to how well their characteristics matches with those
of the different grade definitions.
36
 The job evaluation committee goes through each job description and carefully weighs it in the light
of certain factors like skill, experience etc. In this way it assigns each job to a particular grade or class.
For each grade or class there are different rates of wage.
In this method, Jobs are classified into an existing grade/category structure or hierarchy. Each level
in the grade/category structure has a description and associated job titles. Each job is assigned to the
grade/category providing the closest match to the job. The classification of a position is decided by
comparing the whole job with the appropriate job grading standard. To ensure equity in job grading and
wage rates, a common set of job grading standards and instructions are used. Because of differences in
duties, skills and knowledge, and other aspects of trades and labor jobs, job grading standards are
developed mainly along occupational lines.
The standards do not attempt to describe every work assignment of each position in the occupation
covered. The standards identify and describe those key characteristics of occupations which are significant
for distinguishing different levels of work. They define these key characteristics in such a way as to
provide a basis for assigning the appropriate grade level to all positions in the occupation to which the
standards apply.
job grading is a simple, widely used method in which raters categorize jobs into groups; all the jobs
in each group are of roughly the same value for pay purposes. The groups are called classes if they
contain similar jobs or grades if they contain jobs that are similar in difficulty but otherwise different.
Thus in the federal government’s pay grade system, a “press secretary” and a “fire chief” might both
be graded “GS-10” (GS stands for “General Schedule”). On the other hand, in its job class system, the
state of Florida might classify all “secretary IIs” in one class, all “maintenance engineers” in another, and
so forth.
There are several ways to actually categorize jobs. One is to write class or grade descriptions (similar
to job descriptions) and place jobs into classes or grades based on how well they fit these descriptions.
Another is to draw up a set of compensable factor based rules for each class (for instance, how much
independent judgment, skill, physical effort, and so on, does the class of jobs require?). Then categorize
the jobs according to these rules.
Probably the most popular procedure is to choose compensable factors and then develop class or
grade descriptions for each class or grade in terms of amount or level of the compensable factor(s) in
those jobs. The federal classification system in the United States, for example, employs the following
compensable factors (1) difficulty and variety of work, (2) supervision received and exercised, (3)
judgment exercised, (4) originality required,(5) nature and purpose of interpersonal work relationships,
(6) responsibility (7) experience, and (8) knowledge required. Based on these compensable factors, raters
write a grade definition like that in given Figure . This one shows one grade description (GS-7) for the
federal government’s pay grade system. Then the evaluation committee reviews all job descriptions and
slots each job into its appropriate grade, by comparing each job description to the rules in each grade
description. For instance, the federal government system classifies the positions automotive mechanic,
welder, electrician, and machinist in grade GS-10.
The classification method has several advantages. The main one is that most employers usually end
up grouping jobs into classes anyway, regardless of the evaluation

37
 Grade Nature of Assignment
Performs specialized duties in a defined
functional and program area involving
a Wide variety of problems or situations;
GS-7 Develop information’s, identifies
Interrelationship, and takes action
consists With objectives of the function
or programs served
Level of Responsibility
work is assigned in terms of
Objectives, priorities, and deadlines;
the employee works independently in
resolving Most conflicts; the employee
works independently in resolving Most
conflicts; completes; completed work
is evaluated for conformance to policy;
guidelines, such as regulations,
precedent cases, and policy statements
require considerable Interpretation and
adoption.

This is summary chart of the key grade level criteria for the GS-7 level of elerical and assistance work.

Method they use. They do this to avoid having to work with and price and unmanageable number
of jobs. Of course the job classification automatically groups the employer’s jobs into classes. The
disadvantages are that it is difficult to write the class or grade descriptions, and considerable judgment
is required to apply them. Yet many employers (including the U.S. government) use this method with
success.
Merit
I. It is simple to use.
II. The grade or structure exists independent of the job. Therefore, new jobs can be classified more
easily than the ranking methods.
Demerit
I. Classification judgments are subjective.
II. Some jobs may appear to be fit under more than one category.
III. Broad generalization is used in defining grade.
IV. It requires multiple systems for different types of job.
V. The standard used for comparison (the grade/category structure) may have built in biases that
would affect certain groups of employees (females or minorities).
c) Point Method
It is most widely used method. It along with factor comparison, involves a more detailed, quantitative
and analytical approach to the measurement of job worth. Under this method a quantitative evaluation
of different jobs in terms of various factors is made. Maximum point values are assigned to each of the
job factors required to be considered. Then each job is awarded points for each factor. The wage level
appropriate for each job fixed on the basis of total points scored by it.
l It is an analytical method in which each job is broken down into a number of factors such as skills,
physical effort and responsibility. Points are awarded for each factor according to a pre-determined
scale and then totalled for each job to decide the ranking order. Usually the factors are weighted
according to importance
A set of compensable factors are identified for determining the worth of jobs. Typically the compensable
factors include the following categories :
1. Skill
2. Responsibilities
3. Effort
4. Working Conditions
38
 These factors can then be further defined.
1. Skill
1. Experience
2. Education
3. Ability
2. Responsibilities
1. Fiscal
2. Supervisory
3. Effort
1. Mental
2. Physical
4. Working Conditions
1. Location
2. Hazards
3. Extremes in Environment
Each factor is then divided into levels or degrees which are then assigned points. Each job is rated
using the job evaluation instrument. The points for each factor are summed to form a total point score
for the job. Jobs are then grouped by total point score and assigned to wage/salary grades so that similarly
rated jobs would be placed in the same wage/salary grade.
The procedure for the design of “Point Method” is discussed below:
I. List the type of job to be evaluated.
II. Determine the factors to be used in this method like skill. Efforts, initiative and define them
properly.
III. Determine the number of degrees to be allocated to each factor and prepare a suitable definition
of each.
IV. Assign points to each degree of each factor.
V. Select a certain number of key jobs, say 10-15, and evaluate each in terms of scale so constructed.
VI. Design the wage structure.
Merit
I. It is more analytical and deals with job factors.
II. The factors are sub-divided which ensures accuracy of evaluation.
III. It can be applied in wide range of jobs.
IV. It can also be applied to newly created jobs.
V. The value of the job is expressed in monetary terms.
Demerit
I. The pay for each factor is based on judgments that are subjective.
II. The standard used for determining the pay for each factor may have built-in biases that would
affect certain groups of employees(females or minorities)
d) Factor Comparison Method
Thomas E.Hitten originated this method. This determines the relative worth of the jobs to be evaluated
in relation to the monetary scale. It is often used for evaluating white collar, professional and managerial

39
positions, although it is equally suitable for grading other jobs as well. It is a combination of ranking and
point method. Like rank method it rates the jobs by comparing one job with the other. Like point method
it is more analytical to divide the jobs into compensable factor. Final ratings are expressed in terms of
number.
A set of compensable factors are identified as determining the worth of jobs. Typically the number
of compensable factors is small (4 or 5). Examples of factors are:
1. Skill
2. Responsibilities
3. Effort
4. Working Conditions
Next, benchmark jobs are identified. Benchmark jobs should be selected as having certain
characteristics.
1. Equitable pay (not overpaid or underpaid)
2. Range of the factors (for each factor, some jobs would be at the low end of the factor while others
would be at the high end of the factor).
The jobs are then priced and the total pay for each job is divided into pay for each factor. This
process establishes the rate of pay for each factor for each benchmark job. Slight adjustments may need
o be made to the matrix to ensure equitable dollar weighting of the factors. The other jobs in the
organization are then compared with the benchmark jobs and rates of pay for each factor are summed
to determine the rates of pay for each of the other jobs.
The process involved in this method is:
I. Select the factors and define them clearly.
II. Select the key job, which would serve as a standard against which all other jobs are compared.
III. Allocate wage for each key job to different factors.
IV. Develop a job comparison scale and insert key jobs in them. When all of the key jobs have been
evaluated and wages allocated in this manner a job comparison scale can be constructed.
V. Evaluate the job in question factor by factor in relation to key jobs on job comparison scale. Then
each job is to be evaluated and compared to other jobs in terms of each factor.
VI. Design, adjust and operate the wage structure.
Merit
I. The value of the job is expressed in monetary terms.
II. Can be applied to a wide range of jobs.
III. Can be applied to newly created jobs.
Demerit
I. The pay for each factor is based on judgments that are subjective.
II. The standard used for determining the pay for each factor may have build in biases that would
affect certain groups of employees (females or minorities).
Limitation of Job Evaluation
1. It is not fully objective and scientific. There is considerable scope for subjective judgment and
human error. There is no standard list of factor to be considered and some job factors cannot be
measured accurately.
2. It fails to consider several factor which influence the value of a given job from workers’ point
of view such as security of service, career prospects, social status, etc.

40
3. It makes wage and salary structure inflexible by freezing wage differentials between jobs.
4. It is not well suited to determining the relative worth of the jobs. These job involve considerable
planning, decision making and supervision of others. These executive skills can not be measured
in quantitative terms.
5. Some method are difficult to understand. Workers and trade unions often oppose it. They fear that
it will do away with collective bargaining for settlement of wage rate.

41
 LESSON 4

JOB GRADING AND JOB DESIGN

Dr. Neetu Jain
RDIAS
Institute of Management
Meaning of Job Grades
The process of job evaluation results in rank order of jobs, irrespective of the method followed. As
there are a number of jobs that are performed in an organization, and the number increases with increase
in size and diversity of operations, determining and assigning pay individually for each job will be a
Herculean task. Therefore, this rank order is divided into grades, each of which is defined in terms of
a range of job evaluation points(Armstrong etal,2005).
The points in a job evaluation scheme have no value in themselves. They are simply ordinal numbers
that define position of an entity in a series. For each grade, pay ranges are attached which will take
account of external relativities(market rates) and the need for pay progression. There is no direct relationship
between job evaluation points and rates of pay. All jobs within the same grade will be paid within the
same range of pay. As grades group different jobs together, the grading system introduces flexibility into
the pay structure. People can be moved among jobs by the organization within a grade with not much
change in pay.
Designing Pay Grades
Although grades permit flexibility, they are challenging to design. The aim is to put all similar jobs
within the same grade for pay purposes. Now suppose the point values of two jobs are different but not
so substantially different as to be put into different job grades. Still, they are put into different jobs grades
(though adjacent).As the difference in pay between two grades can be substantial or more as compared
to the difference between points of those two jobs, it may result in pay structure being conceived as
inequitable by the employees (particularly by the one who gets adversely affected). Resolving such
dilemmas requires an understanding of the specific jobs, career paths, and work flow in the organization,
as well as considerable judgment (Milkovich et al., 2005). Company characteristics, labor market
situation, wage settlements, opportunities for advancement and motivational strategies influence the
design aspects of pay structures in terms of number of grades and the length/range of scale of pay in each
grade. Too few grades limit opportunities for progression. Too many grades cause apprehensions about
equity and fairness (Venkata Ratnam, 1991).
The grading process may initially be based on the benchmark jobs. Other distinct jobs may than be
evaluated and graded. This may not be necessary where there are any generic roles( i.e. , those with
basically the same range and level of responsibilities) and it is certain that the characteristics of a
particular role or group of roles are virtually identical to these generic roles. In these circumstances, the
grading may be done simply by matching the role to be graded with an appropriate generic role. Where
there are a large number of non-benchmark individual jobs to be graded, organization often save time by
using the matching process rather than evaluating each one separately.
Establishing Range Midpoints, Minimum and Maximum
Ranges set upper and lower pay limits for all jobs in each grade. A range has three salient features:
a midpoint, a minimum, and a maximum. In the following the midpoint is Rs. 20,000.The range, for the
grade has set at 20 per cent above and 20 per cent below the midpoint. Thus all engineers are supposed
to receive a salary between Rs. 16,000 to Rs. 24,000.

42
 Range Midpoint, Minimum and Maximum

Rs. 24,000 Range Maximum

Rs. 20,000 Range Midpoint

Rs. 16,000 Range Minimum

Grade 2
(Source: Milkovich et al.,p.246)
Size of Range
The size of the range is based on some judgment about how the ranges support career paths,
promotions and other organization systems. The percentage spread (and thus the total range) is frequently
greater for higher level positions on the presumption that there is more leeway to make an outstanding
or very poor contribution in these more important jobs. Top level management positions commonly have
ranges of 30 to 60 percent above and below the midpoint; entry to mid-level professional and managerial
positions, between 15 and 30 per cent; and office and production work, 5 to 15 per cent.
Some compensation managers use the actual survey rates, particularly the 75th and 25th percentiles,
as their range maximums and minimums. Other ensures that the proposed range includes at least 75 per
cent of the rates in the survey data. Still others establish the minimum and maximum separately. The
minimum amount is fixed and the amount between the minimum and the mid-point is determined depending
on how long it takes a new employee to become fully competent. If the training time required is short,
minimums may get closer to the mid-points. The maximums become the amount above the mid-point that
the company is willing to pay for sustained performance on the job. In the end, the size of the range is
based on the judgment that weighs all these factors.
Range Overlap
Overlapping between the two adjacent grades is necessary as an experienced employee in a lower
grade may make a greater contribution than a relatively new employee in the next higher grade. Following
exhibit shows two extremes of such overlaps. The high degree of overlap and low mid-point differentials
in Exhibit (a) indicate small differences in the value of jobs in the adjoining grades. Being prompted from
one grade to another may include a title change but not much change in pay. The smaller ranges in
Exhibit (b) create less overlap, which permit the manager to reinforce a promotion into a new grade with
a larger pay increase.
(a) (b)
Salary (Rs.)

A B C D A B C
Pay Grades
43
Optimal Overlap
The size of differentials between grades should support career movement through the structure. A
managerial job would typically be at least one grade higher than the jobs it supervises. Although a 15
per cent pay differential between manager and employee is suggested as a rule of thumb, large overlap
and possible overtime in some jobs, but not in managerial jobs, can make it difficult to maintain ‘manager-
employee’ differentials. Therefore, it is difficult to lay down such specific rule of thumb.
The question is ‘What is the optimal overlap between grades’? It ought to be larger enough to induce
employees to seek promotion into a higher grade. However, virtually there is no research to indicate how
much of a differential is necessary to influence employees to do so.
Spot Rate
Spot rates may be used for some jobs, often those at senior management levels or those not covered
by the structure. They may also be called the ‘rate for the job’, more typically for manual jobs where
there is a defined skilled or semi-skilled market rate, e.g. , for fitters, plasters, cooks and cleaners.
According to Armstrong, spot rates display the following features:
(i) They are attached to a person rather than a job.
(ii) They are not located within grades and have no defined scope for progression.
(iii) The holder may be eligible for incentive bonuses in addition to spot rate.
(iv) Spot rate plus increases for performance results in a new spot rate.
(v) The sky determinant is the market worth of the person.
Spot rates are suitable for use by:
(i) Organizations which want to pay what they want and not restricted by the grades.
(ii) Small and start-up organizations that do not want to be constrained by a formal grade structure
and prefer to retain the maximum amount of flexibility.
Rational for Grade and Pay Structures
Grade and pay structures serve the following purpose:
l They provide a logically designed framework for implementation of organization’s pay policies.
l They enable the organization to determine where jobs should be placed in a hierarchy, define pay
levels, and scope for pay progression.
l They provide the basic upon which relativities can be managed.
l They provide the basis for monitoring implementation of pay practices.
l Career and pay opportunities available to employees can also be communicated through grade
and pay structures.
Concept of Job Design
In recent decades, human resource managers have realized that what an employee actually does on
the job (design of a job) has considerable influence on his productivity and job satisfaction. Job analysis
helps in developing appropriate design of job to improve efficiency and satisfaction Job design is the
process of deciding on the contents of a job in terms of its duties and responsibilities, on the methods
to be used in carrying out the job, in terms of techniques, systems and procedures, and on the relationships
that should exist between the jobholder and his superiors, subordinates and colleagues. “It is a deliberate
and systematic attempt to structure the technical and social aspects of work so as to improve technical
efficiency and job satisfaction. Job design is an attempt to create a match between job requirements and
human attributes. It involves both organizing the components of the job and the interaction patterns
among the members of a work group.
44
 The main objective of job design is to integrate the needs of the individual and the requirements of
the organization. Needs of employees include job satisfaction in terms of interest, Challenge and
achievement? Organizational requirements refer to creative high productivity, technical efficiency and
quality of work. Today, educated and creative employees demand well-designed jobs. Therefore increasing
attempt are being made to redesign jobs so as to improve the quality of working life. A systematic body
of knowledge on the designing of jobs has been developed after the Industrial Revolution and the large
scale enterprises.
Approaches to Job Design
The main approaches to job design are described below:
1. Classical Approach
Also known as Engineering approach it was developed by F.W. Taylor and his associates. The
principles of scientific management formed the basis of designing jobs in most Organisations.
These principles focus on planning, standardizing and improving human effort at the operative level
in order to maximize productivity. In the words of Taylor, “the work of every workman is fully planed
out by the management at least one day in advance and each man receives in most cases complete written
instructions, destructions, describing in detail the task which he is to accomplish. This task specifies not
only what is to be done but how it is to be done and the allowed for doing it. “Scientific management
offers the following principles for job design:
(i) Task Fragmentation. Every job should be broken into small components in order to improve
technical efficiency.
(ii) Optimization of Technology. Through scientific study and analysis, the best method for doing
a task is developed.
(iii) Standardisation. The method so discovered is standardized through time and motion studies.
(iv) Specialisation. Workers should be selected to perform specific tasks so as to ensure narrow
specialization.
(v) Training. Workers so selected are trained in the most efficient manner for performing the task.
Fragmentation of task into simple operations requiring low level of skill helps to reduce
considerably the time and cost involved in training.
(vi) Individual Responsibility. Each worker is made responsible for a single operation forming
part of the total task. One man-one job thereby becomes the building block of the organization.
(vii) Economic Incentive. Monetary compensation should be used to reward efficient performance.
These principles appear to offer a rational and task-centered approach to job design. Standardisation,
simplification and specialization help to make jobholders experts leading to higher productivity, and
lower costs. But jobs designed on the basis of these principles have following problems:
(a) Narrow Specialisation. A worker performs only one element of the total task. As a result his
full potential is not utilized. The job offers no challenge to the worker.
(b) Routinsation. Due to narrow specialization and task fragmentation, the same operation has to
be repeated has to be repeated again and again. Such repetition causes boredom in the absence
of variety of tasks.
(c) Reduction in Work Cycle. The time interval at which the operation is repeated becomes small
leading to monotony.
(d) Mechanical Pacing. In assembly line jobs, workers have to maintain a regular pace of work.
Machine rather than worker controls the workplace. This causes frustration to workers. Workers
lose interest in the job because they have almost no freedom in the choice of work methods
and techniques.

45
 (e) Lack of Job Pride. Due to narrow specialization, no worker produces an identifiable end
product. Workers cannot take pride in their output.
(f) Techno-economic Appraisal. Technical efficiency is used to judge performance over-looking
human satisfaction. Economic rewards reduce the the worker to the status of an economic man.
(g) Little Interaction. On account of the need for constant attention on a narrow job. Employees
get little opportunity to interact socially with one another.
Thus, the engineering approach to job design fails to take into account the social and psychological
needs of workers. As a consequence, majority of employees become alienated and frustrated. At the
individual level, it may lead to physical illness, poor mental health, and chronic depression, maladjustment
to family and community life. At Organizational level low morale, poor quality consciousness, loss of
interest in work, high labour turnover and absenteeism, resistance to change and even sabotage can occur.
Jobs designed on the basis of classical approach are not appropriate in the modern environment characterized
by increased awareness, improved education and rising expectations of workforce.
Behavioural Approach. The findings of Elton Mayo, Frederick Herzberg and other human relations
experts led to search for alternative ways of designing jobs so as to avoid the dysfunctional consequences
of standardization and simplification. Job redesign, work structuring, job enrichment, participative system
and other similar strategies were developed to improve the quality of work life. The aim of all these
attempts is to design jobs which will not only ensure technical efficiency but will satisfy social and
psychological needs of workers.
The most popular behavioral; approach to job redesign is the Job characteristics model of Hackman
and Oldham. This model is based on the assumption that three key psychological states of a jobholder
determine his motivation, satisfaction and performance on the job, these states are:
(a) Experienced meaningfulness – The degree to which the jobholder experiences work as important
and worthwhile.
(b) Experienced responsibility – The extent to which the jobholder feels personally responsible
and accountable for the results of the work performed.
(c) Knowledge of results –Information about how well he is performing the job.
When a worker experience these state on the job, he feels motivated. He works hard to perform well
to the extent these states are important to the worker. Therefore, motivation, satisfaction and performance
should be integrated in the job design. These psychological states are generated by the following core
job dimensions:
(1) Skill Varity. The degree to which the job requires the person to do different activities so that he
can use a number of different skills and talents.
(2) Task Identity. The degree to which the job requires completion of a whole and identifiable piece
of work.
(3) Task Significance. The degree to which the job has a substantial impact on the work and lives of
others both inside and outside the organization.
(4) Autonomy. The degree to which the job provides freedom, independence and discretion to the
individual in scheduling the work and in deciding the procedures to be used to do the job.
(5) Feedback. The degree to which the job provides the individual with clear and direct information
about job performance and outcomes.
As can be seen from Fig. , the core job characteristic of skill variety, task identity and task significance
contribute to a sense of meaningful work. Autonomy is directly related to feeling of personal responsibility
for results and feedback is related to knowledge about own performance.

46
 Core Job Critical Personal and Work
Characteristics Psychological States Outcomes

Skill Variety Task Experienced High internal work

Identity Task meaningfulness of motivation
Significance work
High quality work
performance
Experienced responsibility
Autonomy For outcomes of the work High satisfaction with
the work

Knowledge of the actual Low absenteeism and

Autonomy result of the work activites turnover

Employee Growth Need Strength

Fig. Job Characteristics Model

Source: Richard Hackman and Greg R. Oldham: Work Redesign, 1980.
These three critical psychological states in turn lead to certain outcomes for both the job and the
jobholders. The psychological states provide intrinsic motivation only for those people who have a high
need for learning and growth on the job. This desire for personal feeling of accomplishment and growth
is called growth need which serves as a motivator.
Hackman and Oldham have also developed a Job Diagnostic Survey (JDS) questionnaire to analyse
jobs. The questions on this survey yield a quantitative score that can be used as an overall measure of
job scope, i.e., propensity of a job to be intrinsically motivating. The formula for calculating this
Motivation Potential Score (MPS) is as follows:
[Skill Variety + Task Identity + Task Significance] x Autonomy x Feedback
MPS=
3
The formula reveals that out of all the job dimensions, autonomy and feedback are most critical. If
score on either of them is 0, the MPS will also be zero which means the job has no motivating potential.
High MPS implies that the job has high motivation potential and vice versa.
Job characteristics model has important implications for job design. It suggests that only those
employees will respond positively to the five core job dimensions who have strong growth needs and
who are satisfied with the company’s internal environment (pay, security, supervision, co-workers).
Therefore, personal traits, and need patterns of a jobholder must be considered in redesigning jobs. The
positive outcomes given in above Fig will occur only when there is a proper fit between the job and
the jobholder.
Hackman and Oldman have suggested the following guidelines for job redesign so as to develop the
five core dimensions in a job:
l Combining Tasks. By combining tasks a longer work module can be formed.
l Forming Natural Work Units. It means identifying basic works items and grouping them into
natural categories.
47
 l Establishing Client Relationships. It involves identifying the client, developing the most direct
contact possible with him and specifying the criteria by which the client can evaluate the quality
of product or service he receives.
l Vertical loading of Job. It implies closing the gap between planning, doing and controlling the
work.
l Opening Feedback Channels. This can be done by establishing client relationships, providing
summary of performance to the worker and allowing him to control quality of work.
Redesign of jobs on the basis of above guidelines leads to formation of semiautonomous or self-
managing groups.
Behavioral approach to job design is a socio-technical approach as it deals with both the technical
and social aspects of a job. It is, therefore, an improvement over the classical approach which considered
only the technical side of jobs. Tavistock Institute of Human Relations, London has carried out several
experiments in the application of the socio-technical approach to job design.
The job characteristics model, however, suffers from some limitations. It is probabilistic and has an
intuitive appeal. But there is little empirical evidence to support it. In one study of bank employees in
India growth need has not been found as a motivator. Job satisfaction and performance depend on the
jobholder’s perceptions of the job rather than actual contents of the job.
Methods of Job Design
Some of the popular methods used to improve the motivating potential of jobs are given below:
1. Job Rotation. It implies the shifting of an employee from one job to another without any change
in the jobs. For example, a back clerk may be shifted from cash counter to token counter, to teller
counter, and so on. The main advantage of job rotation is that it relieves the employee from the
boredom and monotony of doing a single task. The employee gets some variety of work, workplace
and the peers. Job rotation also helps to broaden the knowledge, and skills of an employee.
Management gets employees who can perform a variety of tasks to meet contingencies. This
method also improves the personal worth of the employee.
Job rotation, however, has a very limited potential. It does not change the basic nature of jobs.
Rather an employee is asked to perform several monotonous jobs in place of a single job.
Therefore, the employees who want a challenging and satisfying job still feel frustrated. Moreover,
frequent shifting of employees may cause interruptions in the work routine of the organization.

Job
Rotation

Job JOB Job Enlargement

Simplification DESIGN

Job Enrichment

48
2. Job Enlargement. It is the process of increasing the scope of a job by adding more tasks to it.
The related tasks are combined. The widened and more complex job is expected to the satisfy the
higher order needs of employees. Due to variety of tasks, an employee gets the opportunity to make
greater use of his mind and skill. In the words of Strauss and Sayles,”It implies that, instead of
assigning one man to each job, a group of men can be assigned to group of jobs and then allowed
to decide for themselves how to organize the work. Such changes permit more social contacts and
greater control over the work process.” For example, in a company there are three groups of sales
persons for three different sales functions namely booking orders, delivering the product and
providing after-sale service. Under job enlargement, all the groups are merged together so that
every salesperson performs all the three functions.
Job enlargement reduces monotony and boredom by providing the employee a more complete or
whole job to do. It helps to increase interest in work and efficiency. It is also a method of training
and developing more versatile employees. But it does not increase the depth of a job. Enlarged jobs
require longer training period as there are more tasks to be learned.

3. Job Enrichment. It involves designing a job in such a way that it provides the worker greater
autonomy for planning and controlling his own performance.It is based on the assumption that in
order to motivate employees, the job itself must provide opportunities for achievement, recognition,
responsibility, advancement and growth. Through job enrichment, a job is made more interesting
and challenging thereby removing the functions of narrow specialization. An employee whose job
is enriched will perform the management functions of planning and control so far as his own work
is concerned.
Job enrichment needs to be differentiated from job enlargement. Job enlargement involves a horizontal
loading of the job by adding a variety of operations which the jobholder will perform. On the other hand,
job enrichment consists of a vertical loading of the job so that the jobholder himself controls the planning
and execution of his job. In job enlargement, employees are given more work at the same level of
responsibility whereas under job enrichment an employee is given greater autonomy and responsibility.
Jobs are restructured so that they become more meaningful, interesting and challenging. Controls are
reduced to provide greater freedom of action and to increase accountability. For instance, an employee
may be assigned total responsibility for a complete job. Job enrichment involves grouping together jobs
at different levels.

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 LESSON 5

THEORIES OF COMPENSATION
Dr. Neetu Jain
RDIAS
Institute of Management
Introduction
The multiple influences on compensation decisions mean that compensation theorists face a huge
task. This task is to specify the factors that determine compensation, the manner in which they do so,
and the relative and absolute importance of each. Although this goal has not been accomplished, some
progress is being made. Economists continue their long-term interest in wage theory. Psychologists,
through their study of motivation and other aspects of organizational behavior, are contributing to
compensation theory. Sociologists, through their study of work and exchange relationships, have added
to our understanding of compensation.
Economists have long been concerned with compensation theory. They have viewed employment as
an exchange of labor services for payment in money or in kind. They have distinguished labor markets
from other markets. They have shown how labor markets determine wages. Wage theories designed to
explain economists have developed the determinants of wages and wage relationships for over two
centuries. Wage theory has changed with changes in the economy and with changes in pertinent wage
issues. A major change in wage theory came from the understanding that different kinds of wage theory
were required for different types and levels of wage problems. The general wage level of the economy,
for example, may require an explanation different from those required by the average wage in an enterprise,
wage rates for particular jobs, and wage structures or relationships.
In recent years, economists interested in labor markets and thus wages have largely separated themselves
into two fields. Labor economics is a branch of economics concerned with theory and measurement.
Industrial relations (sometimes called institutional economics) is an interdisciplinary field that draws on
sociology, psychology, law, and personnel management as well as economics. Industrial relations is
largely an applied field that deals with workers or their union in a particular organization.
Compensation policies and practices are based on theories of compensation determinants and
relationships, whether those who make policy or design techniques are aware of it or not. Economists
have long been concerned with compensation theory. They have viewed employment as an exchange of
labor services for payment in money or in kind. Wage theories designed to explain the determinants of
wages and wage relationships have been developed by economists for over two centuries. The general
wage level of the economy, for example, may require an explanation different from those required by the
average wage in an enterprise, wage rates for particular jobs, and wage structures or relationships.
Two distinct branches of Compensation Theories are:
1. Economic Theories
2. Motivational Theories
Economic Theories
Just Price Theory
Although most historical theories of wages are economic, the oldest is essentially sociological. The
just-price theory, followed in the Middle Ages, involved setting wages in accordance with the established
status distribution. Wages were systematically regulated to keep each class in its customary, and hence
“right,” place in society. Higher-status persons got higher wages. The emphasis on equality, the tying of
wages to status, and the preservation of customary relationships, although developed in pre-industrial
times, has a modern ring.

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Classical Wage Theory
During the Industrial Revolution, market forces became dominant and laissez-faire principles were
invoked to free market forces from custom and regulation. Adam Smith set the stage for what is now
called classical wage theory by providing a plausible explanation of the relation between the price of
goods and the amount of labor required to secure them. Although he did not develop a wage theory, he
made a number of observations pertinent to wages. His labor theory of value, which concluded that the
full value of any commodity is the amount of labor it will buy, may be considered a theory of labor
demand. But his observations on wage differentials speak to today’s wage issues. He suggested that
people choose the employment that yields the greatest net advantage. He proposed that there are five
characteristics used to differentiate jobs and thus net advantage:
(1) Hardship,
(2) Difficulty of learning the job,
(3) Stability of employment,
(4) Responsibility of the job, and
(5) Chance for success or failure in the work.
He also identified two quite different standards for comparing things of value: use value and market
value.
l Use value refers to the value anticipated from use of the item. It varies among individuals and
over time.
l Market value refers to the price something will bring. In a free market where demand and supply
are equal, use value will equal market value.
Subsistence Theory
It was Thomas R. Malthus’s theory of population that provided the raw material for the first economic
wage theory. Population, according to the theory, is limited by the means of subsistence: it increases
geometrically whereas the means of subsistence increases arithmetically. David Ricardo translated Malthus’s
theory into the subsistence theory of wages. According to this theory, wages in the long run tend to equal
the cost of reproducing labor, the subsistence of the laborer. This theory, often called the iron law of
wages, indicated that little could be done to improve the lot of the wage earner because increasing wages
leads only to increasing the number of workers beyond the means of subsistence.
The subsistence theory was an explanation of the general level of wages in terms of labor supply.
Any increase in the wage rate above the subsistence level would induce an increase in the birth rate and
therefore in the supply of labor. The expanded labor supply would force the wage rate back to the
subsistence level. Any decrease in the wage rate below the subsistence level would result in starvation
and a reduction in the labor supply. Although the market price of labor might temporarily climb above
or fall below the natural price, the two would converge in the long run.
Wages-Fund Theory
The short-term version of classical wage theory was the wages-fund theory. As described by John
Stuart Mill, this theory explained the short-term variations in the general wage level in terms of (1) the
number of available workers and (2) the size of the wages fund. The wages fund was thought to come
from resources accumulated by employers from previous years and allocated by them to buy labor
currently. Employers were thought to have a fixed stock of “circulating capital” for the payment of wages.
Dividing the labor force (assumed to be the population) into the wages fund determined the wage.
The theory erred in assuming that a fixed fund for the payment of wages exists and that it accounts
for labour demand. Most workers are paid out of current production. Employers balance labour costs
against other costs in determining labour demand. Both employers and workers, however, often talk as
if such funds exist and as if they determine the amount of labour services needed.

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Marxian Wage Theory
The economic and social climate that produced classical wage theory perhaps inevitably produced
Marxian wage theory. Marx accepted the subsistence and the wages-fund theories. He interpreted Smith’s
and Ricardo’s labor theory of value as meaning that labor is the sole source of economic value. His
explanation of the wage-setting process was that the entrepreneur collects the value created by labor but
pays labor only the cost of subsistence. The difference is surplus value, roughly equivalent to profit. The
existence of surplus value means exploitation of labor. Competition among capitalists, Marx argued,
results in the accumulation of labor saving capital (jellied labor). This substitution of capital for labor
results in technological unemployment and a reserve army of unemployed. Because labor is the only
source of value, substituting capital for labor results in a falling rate of profits. The only solution for
capitalists is to spend relatively more on capital and relatively less on labor. In this way, surplus value
can be maintained by further exploitation of labor. This exploitation of labor in turn results in a class
conflict, which would, according to Marx, result in the demise of capitalism.
Although Marx’s assumptions and predictions were faulty, his arguments are still voiced in parts of
the underdeveloped world and by radical economists in the United States. Capital produces value, but it
can be defined as embodied labor. Land also produces value. In the industrial world, labor’s absolute and
relative shares of the fruits of production have continually increased and real wages have risen. Although
many of Marx’s objectives have been realized without revolution, his argument that income distribution
depends on social decisions as well as economic forces remains valid.
Residual Claimant Theory
Francis A. Walker’s residual claimant theory may be thought of as an American version of the wages-
fund theory. Here, the workers demand for wages represents the residual claimant on output after rent,
interest, and profit have been independently determined and deducted. Assigning wages rather than
profits as the residual seems curious, but it does suggest that distribution of income is a matter of
decision. It also permitted Walker to suggest that if labor increased its productivity without the use of
more capital or land, its residual would increase, the germ of a productivity theory.
v The Labour Theory of Value
The labour theory of value or the surplus value theory is based upon Smith’s assumption that the
value of a particular commodity is equivalent to the magnitude of labour involved in it. Accordingly, it
has been asserted that labour deserved the real value of the goods it produced.
v The Marginal Productivity Theory
The marginal productivity theory of wages, although initially based on short-run analysis, is at
present highly significant in determining long-run wage levels. This theory is based on the assumption
of a price economy, perfectly competitive economy, homogeneity and mobility of production factors,
multiplicity of buyers and sellers, perfect knowledge, profit maximization as a guiding force, full
employment of all factors and the law of. diminishing returns. It has been argued that two men working
together will produce more than two times as compared to’ the total amount when they produce separately.
Thus, initially each additional individual’s contribution to the total output, would be more than the total
product while each ‘is working alone. However, there will occur a point where in view of the operation
of law of diminishing returns, the output of an additional individual will be less than the preceding one.
The entrepreneur will employ additional individuals beyond this point until the cost or wage of the
marginal or additional individual is equivalent to the marginal individual’s output. In other words, individuals
will be added so long as marginal revenue product is not equal to marginal cost of the individual.
Explicitly, at this point, his profits will be maximum. This theory is based on short-run and
micro-approaches and examine as to why and how wage is paid stressing the demand for labour.
v The Bargaining Theory
The bargaining theory of wages assumes that wages are determined by interaction of management
and labour in a collective bargaining process. Although this theory does not provide adequate analysis
of source of wages in the long-run, it forms an effective basis for determining wages in the short-run.
52
 v The Investment Theory
The investment theory of wages asserts that individuals are paid in terms of their investment in the
form of training, education and experience Thus, according to this theory wages are determined in terms
of what the individuals “bring to” a job i.e. their investment, although practically they are also paid in
terms of their physical and mental input in the jobs.
Contemporary Labour Market Theories
As mentioned, labor economists in recent years have developed some precise models of economic
variables that bear on labor markets and have tested them empirically. The requirements of careful testing
have meant that models of parts rather than of labor-market operation as a whole have been developed.
Thus wage theory includes the quite well verified models of labor supply, labor demand, the search
process, collective bargaining, wage structures of various kinds, benefits, and the general level of money
wages.
Labor Supply
Labor economists now define labor supply as the amount of work supplied by a given population.
From this definition, four dimensions of labor supply are usually noted: (1) the labor force participation
rate, (2) the number of hours people are willing to work, (3) the amount of effort workers exert at work,
and (4) the level of training and skill of workers.
Labor force participation rates depend on labor-supply decisions within the household that are made
only partially on economic grounds. These rates vary by age, gender, race, and educational attainment.
The labor force participation rate has been shown to vary in the same direction as labor demand.
Variation in hours of work offered by the labor force is explained by the theory of choice between
work and leisure. This theory shows how a rational decision maker would respond to opportunities for
work and leisure. Models may be constructed relating hours of work and household income under various
assumptions. Such an analysis separates the substitution effect (an increase in the price of leisure, which
encourages longer hours) and the income effect (the ability to buy more of everything, which encourages
shorter hours). The sum of these two effects is the total effect of income changes on hours of work.
Human Capital Theory
The quality of labor supplies is explained by human capital theory. Experience, schooling, and on-
the-job training are forms of investment in human capital. So are expenditures designed to improve
worker health and the costs of migration to labor markets offering better employment opportunities.
Human capital theory analyzes the effects of additional experience, education, and on-the-job training
on the quality of the labor force. It also analyzes employee and employer decisions on investment in
human capital. Private investment in schooling is analyzed by comparing the age-earnings profiles of
individuals having differing amounts of schooling. The costs of continued education to the individual
include costs of foregone earnings (the larger) and direct costs.
Human capital theory may yield even more information on the qualitative dimension of labor supply
when applied to on-the-job training. Training within organizations involves costs. To minimize those
costs, organizations usually try to hire and keep experienced employees. On-the-job training can be
usefully divided into general and specific training.6 General training provides skills useful to the organization
the training and to other organizations. Specific training provides skills useful to the former alone.
Employers expect to and do pay for specific training by paying trainees more than they are worth during
training. This cost can be recouped over the period of employment by paying the workers slightly less
than they are worth after the training is completed. General training, however, must be paid for by the
worker through lower wages during the training period.
Marginal-productivity theory
The generally accepted theory of labor demand is an application of the marginal-productivity theory
of the demand for any factor of production where two or more factors cooperate. Because the demand

53
for labor is derived from the demand for a product or service, it is almost always employed in combination
with other productive factors. A demand schedule for labor is a functional relation between a price (wage)
and the quantity of labor demanded. Demand alone does not determine the wage except where the supply
schedule is perfectly vertical (inelastic), a very unusual situation. Demand has no effect on the wage
where the supply curve is perfectly flat (elastic), but it does determine employment. In all other cases,
wages and employment are jointly determined by supply and demand.

W
A
G
E

R
A
T
E

P
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EMPLOYEE HOURS

The downward-sloping portion of this curve shows how the marginal productivity schedule determines
the quantity of labor demand in the short run. This downward slope represents the law of diminishing
returns. Assuming that all units of production are sold at the same price (which they are under competitive
conditions), the marginal-productivity schedule times price is the short-run demand for labor.
Since the demand for labor is derived from the demand for products or services, a shift in the demand
for the products will produce a shift in the demand for labor in the same direction. Likewise, even under
competitive conditions, an increase in costs in one industry may result in substitutions in production and,
if price must be increased, substitution by consumers. Thus, the slope of the demand curves for product
(elasticity) and ease of substitution by the producer affect the shape of the labor-demand curve. In fact,
demand for labor will have more slope (more inelasticity), if it is harder for producers and consumers
to substitute. Smaller ratios of labor cost to total cost (unless the producer can substitute more easily than
the consumer) and more slope (more inelasticity) in the supply of other factors have the same effect.
Shock theory
Marginal-productivity theory assumes that the demand schedule is independent of the wage rate. It
is sometimes argued that this assumption is incorrect, that a wage increase can increase the efficiency
of workers or of management. The assumption that the demand schedule is independent of the wage rate
probably has little merit in developed countries. The opposing argument, called shock theory, assumes
that all organizations have slack and that when threatened increase their efficiency. Thus a new, higher
marginal-productivity curve is created. Shock theory is most plausible when applied to a newly unionized
employer.
Up to this point it has been assumed that the cost of labor to the employer consists only of the hourly
wage. Dropping this assumption permits recognition that there are fixed costs of employment that vary
less than proportionately with the hours an employee works. There are turnover costs, for example,
including recruitment, selection, and training costs, as well as severance pay and increased unemployment-
insurance costs. Other costs, such as some taxes on employment plus contributions to health and welfare
plans, are unrelated to hours of work. Other benefits are not fixed costs unless they are based on hours
worked.

54
 Many turnover costs are related to employee skill level, and employers are more reluctant to lose
skilled employees. Employer provision of greater stability of employment for skilled employees may be
largely explained by these fixed costs. A similar distinction is often made between manual and white-
collar employees.
Motivational Theories
In order to understand which components of remuneration are more effective, we need to understand
the conceptual framework or theories of employee remuneration. Three such theories are -reinforcement
and expectancy theory, equity theory and agency theory.
Reinforcement and Expectancy Theories
The reinforcement theory postulates that a behavior which has a rewarding experience is likely to be
repeated.The implication for remuneration is that high employee performance followed by a monetary
reward will make future employee performance more likely. By the same token, a high performance not
followed by a reward will make its recurrence unlikely in future. The theory emphasizes the importance
of a person actually experiencing the reward.
Like the reinforcement theory, Vroom’s expectancy theory focuses on the link between rewards and
behavior. Motivation, according to the theory, is the product of valence, instrumentality and expectancy.
Remunerating systems differ according to their impact on these motivational components. Generally
speaking, pay systems differ most in their impact on instrumentality- the perceived link between behavior
and pay. Valence of pay outcomes remains the same under different pay systems. Expectancy perception
often has more to do with job design and training than pay systems.
Equity Theory
Adam’s equity theory posits that an employee who perceives inequity in his or her rewards seeks to
restore equity. The theory emphasizes equity in pay structure of employee’s remuneration.
Employee’s perception of how they are being treated by their form is of prime importance to them. The
dictum ‘a fair day work for fair day pay’ denotes a sense of equity felt by employees. When employees
perceive inequity, it can result in lower productivity, higher absenteeism or increase in turnover.
Agency Theory
The agency theory focuses on the divergent interests and goals of the organization’s stakeholders and
the way that employee remuneration can be used to align these interests and goals. Employers and
employees are the two stakeholders of a business unit, the former assuming the role of principal and the
latter the role of agents. The remuneration payable to employees is the agency cost. It is natural that the
employees expect high agency costs while the employers seek to minimize it. The agency theory says that
the principal must choose a contraction scheme that helps align the interest of the agents with the
principal’s own interests. These contracts can be classified as either behavior-oriented (e.g. merit pay) or
outcome-oriented (e.g. stock option schemes, profit sharing, and commissions).
At the first sight, outcome-oriented contracts seem to be the obvious solution. As profits go up,
rewards also increase. Remuneration falls when profits go down.

55
 LESSON 6

EXECUTIVE COMPENSATION
Dr. Neetu Jain
RDIAS
Institute of Management
Executive compensation is how top executives of business corporations are paid. Executive pay is
merely a special case within the topic of compensation, but it does have several twist that deserve our
special attention. It is also known as managerial compensation. Organizations decide executive compensation
packages, consisting of basic pay, allowances , perquisites, stock options etc based on a number of
factors.
Managerial and Executive Compensation Systems
Managerial, and particularly executive compensation have a number of components. Some of these
components are the same as those for other compensation systems but are administered differently, while
others are unique to managerial compensation. The components of managerial compensation are: base
pay, bonuses (short term incentives), capital appreciation plans (long term incentives), deferred compensation
and benefits (including perquisites).
Base Pay
Base pay of managers can represent as much as two thirds of their total compensation or as little as
one third. The percentage tends to vary with organization level. The higher the level, the lower the
percentage of total pay represented by base pay.
Short-Term Incentives
Managerial incentives may be based on short-term or long-term performance. This section discusses
short-term managerial bonuses.
The use of bonuses varies greatly with industry, but more than 50 percent of organizations have some
sort of managerial bonus plan. Those organizations with bonus plans tend to pay somewhat less in base
pay than those without them. Bonus plans can be divided into immediate-cash plans and deferred plans.
Since short-term plans are usually immediate-cash plans, they are covered here. Deferred plans are
discussed in the next section on long-term incentives.
Bonus standards
The manager who receives a bonus receives it because some standard was met during the past time
period, typically a year. As indicated, in pay for performance this standard may be either organizational
or job-related.
The most common form of managerial bonus is based upon organizational profits. But there are a
number of other possible organizational measures, such as sales, productivity, or cost savings of one sort
or another. Individual job-related standards may relate to job outcomes or to the performance of particular
activities beyond minimum expectations.
Bonus standards may be either single or multiple. Profit sharing is a single standard. Organizations
may choose to focus managers on a number of variables that they feel are important measures of success.
These may include combining organizational and job measures. Each variable must be weighted when
multiple criteria are used. The problems with multiple plans are that they are more complex and therefore
not as understandable. The manager may have a hard time knowing what he or she will receive, since
the factors may overlap or cancel each other out. Although profits may be the most popular organizational
measure there are a number of other ones.
Long-Term Incentives
In contrast to short-term incentives, which are ordinarily paid in cash, long-term incentives are
usually deferred. The purpose of long-term incentives is to tie the executive into the long-term success

56
of the organization. In today’s competitive business climate, when American business is being criticized
for its focus on short-term profits, these longer-term incentives take on added importance.
Long-term managerial incentives are usually restricted to top management, the 5% percent at the top
of the organization. The exception to this are stock option plans, which are now being granted to lower
levels of employees. These incentives usually involve the granting of rights to the executive to become
a stockholder of the organization at a reasonable cost today so that if the organization does well in the
future, the stock will be of significant value.
This form of incentive has become more popular in recent years because of tax advantages that can
be achieved through this form of incentive. One of the problems has been that the tax laws have changed
over time, and plans that are attractive and useful today may no longer qualify under tomorrow’s tax laws.
Stock option plans
Basically under a stock-option plan the manager is offered stock at a set price. He or she may
purchase that stock at any time within a period specified by the plan. If the value of the stock rises, the
manager gains a considerable value amount. Exercising the option does take money, however, and this
is often a problem for the manager. Taxation is another problem. Finally, the executive may not always
be able to take advantage of increases in the price of the stock, since he or she may not use insider
information when selling the stock.
Stock Appreciation Rights (SARs).
These types of plans work like stock options, but the manager does not have to buy the stock. As
with a stock option, the manager is granted an option at a stated price. The manager then may call in
that option at any time during an established period. But rather than having to purchase the stock, the
manager receives from the organization the difference between the current market value of the stock and
the stated option value of the stock. This saves the manager from having to come up with the cash
necessary to purchase the stock. However, many plans restrict the amount of possible gain to 50 to 60
percent of growth in the stock’s value. The gain is taxed as ordinary income to the manager when
received, but there is no tax obligation when the rights are offered. This incentive plan provides a cash
incentive over a longer period but no ownership advantages.
Restricted Stock Plans.
In this type of plan the manager is granted a certain number of shares of stock as a bonus but may
not sell those shares until certain conditions have been met. These conditions usually involve holding the
stock for a period of time and remaining employed with the organization during that period. Another
condition may be meeting some performance objectives on the job. As far as taxes are concerned, the
lifting of the restrictions creates an ordinary income liability for the difference between the current value
and employee cost. The manager may choose, at the time of the award, to be taxed on the current value
of the stock, but any appreciation would be taxed at time of sale.
Phantom Stock Plans.
In some circumstances it is impossible or undesirable to allow managers to have stock. This may be
because the organization is closely held and does not want ownership dilution. Phantom stock plans can
work well in these circumstances. In these plans the manager is awarded units that represent shares of
stock. These units typically mature at some time, ordinarily four to six years. At maturity the manager
is paid the then-current value of the stock or the difference between the original value and current value.
Obviously, the manager does not have to invest in the stock in this case. Again, the award is treated as
ordinary income when received. Determining the current value of the stock can be a problem. Where the
stock is not widely traded there is no real market value.
Performance Share Plans.
In this type of plan the manager is granted performance units that represent shares of common stock.
He or she earns these shares through the performance of the organization. For instance, a manager might
57
be granted 100 units. If the organization’s earnings per share averaged 10 percent growth over 5 years,
the manager would receive 25 percent of the shares. If the earnings per share averaged 15 percent growth
over five years, the manager would receive up to 100 percent of the shares. Typically the payoff in this
type of program is 50 percent stock and 50 percent cash based upon the current value of the stock. The
manager is taxed on both the cash and the value of the stock as ordinary income.
In all these plans there are three common themes. One is to reward the manager for organizational
success. The second is to establish performance goals for the manager that reflects this success. The third
is to try to maximize the value of the reward to the manager by taking advantage of the tax laws. The
first two are relatively stable goals, but the third is constantly changing. The value of and interest in
different long-term managerial incentives will continue to change with changes in the tax laws.
Deferred Compensation
Deferred compensation plans are promises to pay future retirement benefits (often with death benefits)
and to supplement qualified retirement plan benefits levels. However, technically they are “unfunded”
plans and are nothing more than a promise of a company to pay benefits in some future year to managers
who will no longer be with the organization. Managers, then, are creditors of the organization and stand
in line just like other creditors should financial problems befall a firm.
Golden parachutes
Another form of deferred compensation is a “golden parachute.” A golden parachute provides pay and
benefits to an executive after being terminated due to a merger or acquisition. Golden parachutes extend
pay and benefits for a period of time, usually one to five years. There are two reasons put forth for doing
this. The first is that it makes recruitment easier, since it limits the risk for executives for unforeseen
future events (such as a hostile takeover). They are also attractive to organizations because these payments
can be treated as business expenses.
Time-off
Although their time-off provisions are the same or higher, managers tend not to take advantage of
them as readily as other groups. It is sometimes necessary to insist that managers take the time off that
is available to them, both because they need that time off and because a large liability can be created for
the organization, if a category like vacation time is allowed to accrue.
Perquisites
This is a set of special benefits available to managers, primarily top managers, which are designed
to satisfy the special needs of this group. There are a number of perquisites. The first category is internal.
These perquisites consist of items that are part of the work setting of the manager, such as special offices
and furniture that distinguishes the status of the manager. A second category, external perquisites, has to
do with conducting business outside the organization, and may include a car, entertainment expenses, and
club memberships. The last category is personal perquisites. This category consists of a wide variety of
items, such as free medical examinations, low-cost loans, and financial or legal counseling. The last
group is distinguished from the first two in that it is usually taxable to the employee.
High Pay of Executive—A Global Phenomenon
Almost every literary reference that contains the discussion on executive compensation, talks invariably
about high pay of executives particularly of CEO and the directors. Rise in pay of such executives is also
reported to be many times more than the rise in the pay of the non executives and the rise in rate of
inflation. In India too, management graduates get very high compensation packages. Average domestic
salary in placements of 2006 was approximately Rs. 9.66 lakhs per annum and average International
salary in the same placement was $92,500 (Rs. 41.6 lakh) approximately (Business Today (15(9), 15(14).
A graduate from international School of Business, Hyderabad reported very high salary $230,000 per
annum approximately.
Another feature of executive compensation is that executives in the private sector receive considerably
higher compensation than their counterparts in the public sector. A survey reported in the Economic
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Times, dt.5.10.06 found an upward trend in the compensation of Chief Executive Officers (CEO), middle
level executives and even entry level executives in the private sector.
The Issue of Reason Ableness of Executive Compensation
Extraordinary salaries for executives are justified on the grounds of economics and motivation. In
economic terms, executives are expected to demonstrate good decision making abilities. As it is not
possible for every one to demonstrate such high intellectual abilities, the supply of qualified executives
becomes scarce and attracts higher price. As all organizations must pay competitive price for executives
to retain them (otherwise they will be lost to competitors), salaries go up further.
However, there are others who say that executives compensation, most of the times, is not related to
company’s performance. Even if, it is, company’s good performance can not be attributed solely to
executives’ work as there are other contributing factors also. Moreover, increase in executives’
compensation, at times, has been found to be disproportionate to improvement in company’s performance.
Reasons for High Executive Compensation
From the above discussion it is clear that executive compensation is a controversial issue. Still the
number of organizations which pay their executives princely is increasing. Possible explanations for
executives’ high compensation are discussed as under:
1. Social Comparison: Executive salaries bear a consistent relative relationship to compensation of
lower level employees. When salaries of lower level employees rise in response to market forces,
top executive salaries also rise to maintain the same relative relationship. In general, managers
who are in the second level of a company earn about two-third of CEO’s salary, while the next
level down earns slightly more than half of a CEO’s salary. An important source of criticism
about executive compensation, in general, is the gradual increase in the spread between executives
compensations and the average salaries of the people they employ.
2. Economic Approach: That the worth of executives should correspond closely to some measure
of company’s success, such as profitability or sales. Besides having intuitive sense, numerous
field studies have supported this reasoning.
A recent article analyzing the result from over 100 executives’ pay studies found empirical evidence
that firm size (sales or number of employees) is, by far, the best predictor of CEO Compensation. Size
variables are nine times better at explaining executive compensation than are performance measures. Two
studies combined both social comparison and economic explanations. They found both the variables to
be significantly affecting executive salaries.
3. Agency Theory: It argues that executive compensation should be designed to ensure that executives
have the best interests of stockholders in mind when they make decisions. Keeping this in mind,
some long-term incentive plans are devised. The most common plan is “stock options”. An
executive is given the option to purchase shares of the company at some future date for an
amount equal to the fair market price at the time option is granted. There is built-in incentive for
an executive to increase the value of the firm.
4. Self Motivation: It incorporates the political motivations that are an inevitable part of the
corporate world. Sometimes, this argument has validity. CEOs make decisions that aren’t in the
best interests of the firm and its shareholders. A variant of this view suggests that the normal
behaviour of a CEO is self-protective. CEOs will make decisions to solidify their positions and
to maximize the rewards they personally receive. As evidence of this self-motivated behaviour,
consider the following situations.
(i) If the CEO is truly underpaid: A compensation consultant is hired to survey actual competitors
of the company. The consultant reports to the Board of Directors that the CEO is truly
underpaid. Salary would be increased.

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 (ii) If the CEO is not underpaid and the company is doing well: The compensation consultant
hired is recommended to survey specifically some companies selected on the basis of
paying high amounts as executive compensation. The consultant obviously reports to BOD
that the CEO is truly underpaid. Hence, salary would be increased.
(iii) If the CEO is not underpaid and the company is doing poorly. A compensation consultant
is hired. The CEO laments with the consultant that salaries are low for the top management
and that there is a fear that good people will start leaving the company and going to
competitors. Of course, no one ever asks why the company is underperforming if it has
such a good management team. Anyway, the result is that the consultant recommends a
salary increase to avoid future turnover.
Thus, it can be said whatever is the situation, CEO’s compensation increases. Therefore, executive
compensation is under close scrutiny by an outraged public, and more importantly, the angry shareholders.
5. Government Regulations : Government of every country makes laws and rules in response to
complaints about excessive executive compensation. They put a maximum limit on the amount which can
be paid as managerial remuneration. However, this limit itself becomes a reason for high executive
compensation as the compensation can be increased up to that limit without inviting legal hassles.
Annual Incentive Plans for Executives
According to Armstrong etal., the principle advantage for providing an annual incentive to executive
is to motivate a change in behavior and hence drive performance improvements. Other factor are:
(a) making executives aware of the key measures of company performance
(b) the need to provide a market-competitive remuneration package; and
(c) putting pay ‘at risk’ can reduce executive remuneration costs in year where performance is poor.
Armstrong et al., discuss the following aspects of executive incentive and bonus schemes:
(1) The basis of the strategic decision to have executive incentives
The main question to be answered is : What do executive have to do and achieve for the company
to be more successful? A good scheme will ensure that executives concentrate on business
priorities.
(2) Relationship of executives’ incentives with other components of their reward package.
This means :
(i) reviewing basis salary and benefit packages to ensure that they are competitive. So if
benefitis increased, salary increases may be put on hold, so long as the sum total of the two
remains competitive; and
(ii) deciding what the incentive scheme is expected to contribute in addition to other performance
related payment systems.
(3) Defining the target group
Only those executives should be included in the scheme who can exert personal control over the
selected performance measures as individuals or as members of a team. This will include members
of the board and two-three tiers down the hierarchy. Though common measure for directors is
based on overall company profitability, other participants may need different criteria. Therefore,
such incentive schemes are very challenging to design.
(4) Main feature of Executives’ incentive Schemes
(i) the choice of performance measures, which lies between financial or non-financial objectives
or a combination of the two;
(ii) how non-financial objectives should be measured;
(iii) the extent to which the scheme should be tied down to a formula or should allow an
element of discretion when making payments;
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 (iv) the mechanism for combining multiple performance measures; and
(v) the action that should be taken over any ‘windfall’ profits.
(5) Financial performance measures
The principal financial performance measures are profit before tax, profit after tax, earning per
share, cash flow, return on capital or assets employed, other specific to individual businesses e.g., sales
volume, and market share.
(6) Non-financial targets
For example, the completion of a project, with agreed objectives, within a time limit. The agreed
objectives may be cost reduction, increase in productivity, or improvement in quality, or customer service
levels, or others.
(7) The targets mix
The mix of performance criteria between financial and non-financial measure will depend on the
requirements of the business and the particular demands made on the individual executives in the scheme.
(8) Discretionary elements
The scheme may also provide that the chief executive or the remuneration committee of the board
will be authorized to reward a manager for exceptional performance ‘beyond the line of duty’ which
would not be adequately recognized by the moral measures.
(9) Links with performance management
There is always the risk in any incentives scheme that some important aspect of the job—such as
development, leadership or team building is neglected because the executive concentrates only on those
areas where short-term rewards can be achieved. Discussion on the setting and achievement of targets
should take place as part of the normal performance procedure so that factors not covered specifically
in the scheme are also dealt with.
(10) Level of payments
Often three dimensions are required on the level of incentive payments:
- the target level expressed as a percentage of base salary;
- the starting point for incentive payments (threshold); and
- the limit, if any, to the maximum payment that can be made, and the intermediate levels of
performance.
(11) Treatment of windfall profits
The scheme must provide for the treatment of windfall profits-profits arising from circumstances
outside the control of executives-such as the sale of company assets. A balance is required to be maintained
between complete denial of share to executives or completely giving them the credit.
In case of windfall losses also, normally the scheme should comphasize on a portion of the losses
to be shared by the higher levels.
(12) Tax planning
The scheme should see to it that the given incentives minimize the tax impact on individuals as well
as the organization.
(13) Administering an incentive plan
The incentive plan should be set up by the board or the remuneration committee. To ensure that the
plan is run properly and that the shareholders’ interests are protected, the rules and procedures are laid
down in the rule book or annual letter and given to each member. The points that are covered are:
(a) Scheme objectives in relation to the corporate plan;
(b) Eligibility to join the scheme;
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 (c) Timing of the payments;
(d) Accounting standards used, indicating whether the scheme is related to the audited or to the
management accounts; and
(e) A caveat which states that the scheme will be reviewed periodically.
According to the BW Gallup survey on salaries, 82% employees reported to be comfortable with the
idea of variable pay (Business World, 22 February, 2006). The survey also reported increase in the share
of variable pay as one moves up the organization.
Indian Practices
Executive Compensation in INDIA is basically built around three important factors
P Job complexity
P Employers ability to pay
P Executive human capital
In a well publicized front page news sometime back The Economic Times mentioned about the
miserable salary levels of top executives in public sector units in India. For example the State Bank of
India chief is paid 10% of HDFC bank Managing Director, BHEL’s chief getting about Rs 10 to 12 lakhs
per year as against ABB’s MD getting nearly Rs 40 to 50 lakhs; etc. The salary levels in private sector
above the packages offered to the executives in public sector for various reasons such as : overstaffing,
inefficient processes, pressure on margins due to competition etc.

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 LESSON 7

COMPENSATION POLICIES
Dr. Neetu Jain
RDIAS
Institute of Management
Policies are guidelines for action. They are decisions which are applied to recurring situations.
Therefore, they are called standing decisions.
Various forms of wage and salary policies have been developed, differing according to such factors
as the nature of the business and its location. Because wages and salaries normally constitute a substantial
part of total cost, it is often advisable that the policy recognize competitor’s wages and salaries levels
as well as the levels of the salaries in a geographical area. This is what the industry-cum-region formula
states.
The Compensation Plan consists of salary policies, the schedule of salary ranges and rates to which
positions are assigned, and the approved Job Title Listing for staff positions. These are the official
components for compensating staff employees.
The traditional approach to wage and salary policy has been to recognize that wages and salaries must
be at a level which is adequate to attract, retain and motivate employees competent to perform the task
assigned to them. But this approach is not acceptable where it looks upon human labor as a commodity
subject to the economic law of supply and demand. It fails to recognize human factors, including a desire
of better way of life.
The most prevailing general wage and salary policy is one which relates wage and salary levels in
an organization to those of its competitors, either within its own industry or with those who are competitors
for labor in the geographical area. A company may adopt a policy like this: “we shall pay wages and
salaries which approximate the average of the other companies in the industry in the local geographical
area.”
Another form of wage and salary policy is the formula approach which recognizes the changes in cost
of living and productivity as a basis for wage changes. There are so many wage incentive plans which
recognize the increase in productivity of workers for the increase in wages. but trade unions resist these
and argue that cost of living index in workers must be considered .it is significant to note that in order
to avoid criticism, many organization follow a generalized policy when they say, ‘we intend to pay wages
and salaries which will fairly and equitably reward the employees for a fair day’s work’. However a
statement of this sort being unrelated to specific standards offers maximum flexibility in interpretation
but may not be acceptable to employees who prefer a more tangible form of policy. The objectives of
wage and salary policy should be to recognize the value of all jobs in relation to each other within the
enterprise, to ensure stable earnings to the employees, to enable individuals to reach their full earnings
,to ensure employees share in the organization prosperity as a result of increased efficiency.
Types of Compensation Policies
According to Dunn et al. , compensation policies should be established to cover at least the following
compensation subjects:
(1) the general compensation level;
(2) the wage and salary structure; and
(3) formulas (based on time or productivity) governing disbursement of wage or salary funds to
individuals.
Each of these compensation policies should be related to specific compensation objectives- recruit,
retain and motivate individuals and teams to work towards the achievement of organizational goals.

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 According to Decenzo et al., pay can be determined absolutely or relatively. Since a pay system set
by a single criterion for a whole nation or the world is not possible, pay for each individual is set relative
to the pay of others, Pay for a particular position is set relative to three groups:
(i) Employees working on similar jobs in other organizations. They are called pay- level decisions
which aim at keeping the organisation competitive in the labour market. This decision is made
through pay survey.
(ii) Employees working on different jobs within the organizations. This is known as pay structure
decision. The pay structure involves setting a value on each job, within the organisation relative
to all other jobs. This uses an approach called job evaluation.
(iii) Employees working on the same job within the organisation. The decision related to this group
is called individual pay determination.
Development of a Compensation Philosophy
Before an organization actually develops a compensation plan, there are several questions that need
to be answered. Taking the time to consider and answer these questions will make the process of
developing and administering a compensation plan much easier and will result in the development of a
compensation plan that more closely matches the organization’s goals and objectives.
1. What is the goal of the organization’s compensation system? In addition to attracting and
retaining qualified employees, is there an intent to reward employees for good performance,
motivate good performance, and/or create or reinforce a particular type of organizational climate?
2. What is the communication policy? How is the organization going to communicate the
compensation plan to employees once it has been developed? Is the organization prepared to
evaluate the effectiveness of any such communication? If so, how?
3. How will decisions regarding pay be made? Who will be involved in these decisions? What
decision guidelines will need to be developed?
4. What is the organization’s desired market position relative to pay? Will the organization choose
to pay market rates, above market or below market? How does the desired market position fit
with other strategic goals? Are there any competitive factors involved that will determine the
pay strategy?
5. What is the desired mix between benefits and cash? Since benefits are an important form of
compensation, how does an organization use them to maximize the effectiveness of the
compensation plan?
6. What does the organization pay for? Does it pay for performance or seniority or some combination
of the two?
7. What is the role of performance appraisal in the organization? How important is performance
appraisal and why?
8. How will the organization manage change to the compensation plan once it has been developed?
What systems need to be in place to implement any changes including deciding when change
is necessary and who will make these decisions?
9. How does the compensation philosophy and plan fit with the rest of the organization? How can
the compensation practices reinforce other overall management philosophies and objectives?
Compensation Strategy
Compensation or reward strategy can be defined as all that an organization wants to do in the long-
term to develop and implement reward policies, practices, and processes that will further the achievement
of its goals. It is a declaration of intent, which establishes priorities for developing and acting on reward
plans that can be aligned to business and HR strategies and to the needs of the people in the organization.

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 According to D. Brown (2001), reward strategy is ultimately a way of thinking that can be applied
to any reward issue arising in the organization, resulting in value creation.
Compensation strategy is a guideline or framework against which compensation decisions can be
made and market data can be interpreted. The purpose of compensation strategy is to align compensation
programs and practices with the desired mission, strategy and culture of the organization. An effective
compensation strategy produces compensation plans that align the interests of the employees with those
of the organization.
Objectives of Compensation Strategy
Reward strategy is an undertaking about what is going to be done in the future. It is concerned with
the direction that should follow in developing the right mix and levels of financial and non-financial
rewards to support the business strategy. It will set out:
(ii) the underlying guiding principles (the reward philosophy);
(iii) the intentions- what is proposed;
(iv) a rationale –why is it intended to be done; and
(v) a plan- how we propose to do it.
According to Henry Mintzberg et al., (1988), there are five different meanings that can be attached
to strategy;
(1) Plan- a unified, comprehensive, integrated plan designed to ensure that the objectives are
achieved;
(2) Ploy- a manoevure to outwit an opponent or a competitor;
(3) Pattern – consistency in behavior over time;
(4) Position- how the organization wants to be seen in the market place, whether as a leader or a
follower; and
(5) Perspective – an organization’s fundamental way of doing things. Also called the corporate
culture. It permeates internally within the organization so that all employees see the strategy
and feel part of it.
The Structure of Compensation Strategy
The basic strategic planning questions that need to be answered while developing the structure of a
reward are:
(i) Where are we going?
(ii) How are we going to get there?
(iii) Why do we want to get there anyhow?
(iv) What values or guiding principles should be adopted in implementing the strategy?
The structure of a reward strategy could be built around the four pillars as follows:
(1) A definition of guiding principles – the values that are believed to be necessary in formulation
and implementation of strategy.
(2) A statement of intentions- the reward initiatives that are proposed to be undertaken.
(3) A rationale- the reason why the proposals are being made, how they will meet the business
needs, and how people issues should be addressed.
(4) A plan – how, when and by whom the reward initiatives will be implemented.
Compensation Plans and Business Strategy
Remuneration plans, like any other HR activity, must become an input to formulating a business
strategy. But in most companies, this integration rarely occurs. The general practice is to pay what
competitors pay or to adhere to the “corporate policy”. The actual remuneration plan should not be

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strictly a matter of what is being paid in the market place. Instead, wage and salary plans must derive
from an assessment of what must be paid to attract and retain the right people, what the organization can
afford, and what will be required to meet the organization’s strategic goals. Different salary and wage
strategies can be applied to firms that differ in (i) their business strategies, and (ii) their market position
and maturity.
In companies that are growing rapidly, business strategy tends to be focused on investing to grow.
To be consistent with this business strategy, the remuneration strategy should stimulate an enterprising
and entrepreneurial style of management. For this purpose, the company should emphasize high cash
payments with above-average incentives. In ‘mature’ companies, its business strategy is oriented primarily
towards managing earnings and protecting markets. A remuneration strategy must have a blend of average
cash payments, moderate incentives and standard benefits and should aim at rewarding management
skills. In an ‘aging’ company, the most appropriate strategy is to harness earnings and reinvest them
elsewhere. Remuneration strategy should therefore aim at control of costs. To improve such a strategy,
standard benefits are combined with below-average cash payments and modest incentives are tied directly
to control costs.
Thus companies do the following, viewing remuneration from a strategic perspective:
1. They recognize remuneration as a pivotal control and incentive mechanism that can be used
flexibly by the management to attain business objectives.
2. They make the pay system an integral part of strategy formulation.
3. They integrate pay considerations into strategic decision-making processes, such as those that
involve planning and control.
4. They view the company’s performance as the ultimate criterion of the success of the strategic
pay decisions and operational remuneration programs.
Basic Principles of Successful Compensation Strategy :
1. Align your compensation with your organization’s cultural values and strategic business goals.
2. Link compensation to the other changes such as Reengineering, TQM etc.
3. Tune your compensation programme to support your change initiatives.
4. Carry out continuous improvement in compensation program. Review on regular basis.
5. Be selective in compensation approach. Do not be caught in latest trend. Explore all available
options and then decide on the solution that are right for the organization, its culture and the
changes through which company is going through.
6. Rewards are not viewed as the complete suit of monetary and non monetary rewards but the work
environment offered to the employees such as corporate culture, freedom to work independently
and opportunities to develop skills also counts.
7. Integrate pay with other people processes i.e. how work is designed, how people are selected,
developed and their performance is measured.
8. Democratize the pay process by making every executive, manager and supervisor accountable for
their part of the compensation program.
9. Demystify compensation since it is organizational process, communicate continuously, educate,
share success and acknowledge setbacks.
10. Measure performance based on financial productivity, quality improvement, economic value
(EVA) or customer service.
Developing Compensation Strategy
Armstrong et al. , have described formulation of corporate strategy as a logical step-by step process
for developing and defining a sense of direction (Exhibit 1) This incorporates ample provision for

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consultation, involvement and communication with stakeholders; these include senior managers as the
ultimate decision makers as well as employees generally and line managers in particulars.
In practice, however, reward strategy is hardly formulated following the linear and logical process.
Therefore, another concept stated is that of ‘logical instrumentalism” , which states that strategy evolves
in several steps rather than being perceived as a whole. Another view is that strategy formulation is not
necessarily rational and continuous. Though normally, strategic planner should first formulate strategy
and then implement but often he may act first, then think, i.e. formulation of reward strategy has to keep
taking note of changes occurring in organization’s internal and external environment.

The financial considerations of affordability and profitability loom large in the minds of chief executives
and financial directors.

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 Compensation strategists must also track emerging trends and may modify their strategies accordingly.
It is necessary to have reward strategies laid down as a basis for planning and communication. But such
strategies should be changed according to changes taking place in the environment. There are certain
criteria that can be used to determine whether the present strategy will be effective in the present form
only or some change is required:
(1) They have clearly defined goals and well defined link to business objectives.
(2) There are well designed pay and reward programmes, tailored to the needs of the organization
and its people, and consistent and integrated with one another.
(3) There are effective and supportive HR and reward processes in place.
Developing an Aligned Reward Strategy
Question to Ask:
1. What are our company’s key success factors? What must our company do,to be successful in
fulfilling its mission or achieving its desired competitive position?
2. What are the employee behaviors or actions necessary to successfully implement this competitive
strategy?
3. What compensation programs should we use to reinforce those behaviors? What should be the
purpose of each program in reinforcing each desired behavior?
4. What measurable requirements should each compensation program meet to be deemed successful
in fulfilling its purpose?
5. How well do our current compensation programs match these requirements?
(Source: Adapted from jack Dolmat-Connell, “Developing a Reward Strategy that Delivers
Shareholder and Employee Value,” Compensation and Benefits Review, March-April 1999,
p.51.)
Elements of Compensation Strategy:
The generally accepted elements of compensation strategy include the following:
1. Relative importance of attraction, motivation and retention
2. Relative importance of market competitiveness vs. internal equity
3. Appropriate competitive market(s) and desired degree of competitiveness
4. Timing of compensation data against the market– lead, lag, lead/lag
5. Factors of pay
6. Salary administration and decision making
1. Attraction, Motivation & Retention
While all three objectives are important, attraction and motivation are relatively more important to
the successful achievement of strategic plan than retention. Given this, staff pay strategies will be more
like those found in competitive businesses and less like those in government. Greater emphasis on
competitive pay, starting salaries, administrative flexibility, the linkage of pay and performance and the
consideration of variable pay systems will assist in the achievement of the organisations’s strategy and
mission. Competitive starting salaries are needed to attract talented employees.
Once competitive pay ranges are established, increases in staff pay will be tied to the achievement
of performance standards. The culture of entitlement, where continuing employees expect the budgeted
salary increase percentage, will be abandoned. Under the recommended compensation strategy it will
become understood that annual pay increases will vary among employees based on performance
achievement. No annual increase in pay rate will be possible, where performance has been unacceptable.
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 Retention is not unimportant and turnover must be managed, particularly in key knowledge and
service positions. However, some natural attrition will be beneficial to improve performance and
productivity and justify more competitive compensation. Doing more with fewer, better-paid and highly
motivated staff will be beneficial in order to achieve its overall strategy.
2. Market Competitiveness Vs. Internal Equity
The compensation strategy emphasizes market competitiveness slightly more than internal equity.
This is driven by the need to acquire talented, highly motivated knowledge and other key-skill workers
to meet the strategic objectives.
This compensation strategy does not suggest that internal equity is not important. Systems and
procedures for gauging the relative worth of jobs within and among departments and divisions are
necessary and will be a significant design factor in any compensation plan re-designs. A system design
that includes and projects perceived fairness and internal equity is a strong cultural imperative, as well
as a requirement to minimize legal exposure.
3. Appropriate Competitive Markets and Degree of Competitiveness
Depending on the job, organisation competes with all industries, as well as, local, regional, national
and international geographic markets.
Inherent in the common design principles of traditional salary ranges, is the concept that the midpoint
of the salary range to which a position is assigned should approach the “market” rate for fully competent
position incumbents. Salary range midpoints will generally reflect the desired market position for a given
job (e.g., market median, 75th percentile, etc.), regardless of the salary structure design ultimately adopted.
Organisation must manage and administer salaries around the salary range midpoints, rather than the
range minimum as is presently the case, to successfully implement this strategy.
4. Timing of Compensation Data
The competitive market for salaries is dynamic The market for hot-skill jobs (e.g., information
technology workers and pharmacists) has significantly outpaced this general rate of increase. Sound
compensation management practices require annual adjustments to salary ranges and merit increase
budgets based on market data.
In the course of the one-year period during which this data will be relied upon for compensation
decisions, the market itself will continue to move. Therefore, data effective at a point in time at the
beginning of the year will “lag” the market the entire year. Projecting the market’s position at year-end,
and adjusting compensation ranges accordingly allows one to “lead” the market.
A “lead/lag strategy” is broadly accepted as efficient in balancing salary costs with competitiveness.
This strategy is favored by many organizations because of its “middle ground” position. It is not so
conservative as to detract from the organization’s ability to compete. Yet, it is not so aggressive as
leading the market for the entire year, with a resultant higher cost.
5. Factors of Pay
Factors of pay are the underlying criteria that determine differences in salary levels, e.g., knowledge,
skill, experience. Organisation desires a market-driven, pay-for-performance compensation plan that
rewards individual results. Differences in pay from one classification to another should reflect differences
in market compensation. Where market data is not available for a specific job, placement in the salary
structure should be based on critical competencies needed to perform the job. Differences in pay among
incumbents within the same classification should reflect the competence and performance of the individuals.
6. Salary Administration & Decision Making
The administration of salaries will be flexible and responsive to market demands, with decisions
made at the lowest possible level. Supervisors and managers will be empowered to make decisions
appropriate to their level. Salary administration decisions should reflect the desire to pay a fully competent
employee at the desired market level, which is reflected in the salary range midpoint.
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Agility and flexibility can be achieved through the use of salary structures that have fewer, broader salary
ranges. The concept of “gray area” jobs will be eliminated through the implementation of a flexible pay
plan that is able to recognize need for a broad range of skill sets. The recommended compensation
strategy encourages the exploration of career paths, skill-based and competency-based pay progression
approaches.
Salary administration guidelines dealing with the timing of budget allocations, performance appraisals,
promotions and salary increases will be aligned to reward performance on a timely basis. Salary
administration guidelines will allow for career advancement opportunities within each organization unit.
Other Elements that make foundation of Compensation strategy
Five important elements that make up the foundation for pay strategy are as following:
Pay Philosophy: The organization’s concept of how employees will be compensated. It communicates
the employer’s direction and intent about employee’s salaries. An organization’s pay philosophy must be
simply stated, practical in its approach and application, and clearly communicated. It is a vitally important
component in preparing management to understand and apply employee salaries and salary changes in
ways and circumstances that consistently support the employer’s strategic goals. Pay philosophy is the
core element in developing a successful pay strategy.
Pay Competitiveness: Easy to understand but difficult to achieve and communicate. The main
reason, for most public sector employers, is the general unpredictability of operating budgets, which often
negatively impact the organization’s ability to fund employee salary increases. Most employers address
pay competitiveness issues from only a tactical perspective, focusing on the individual situation as the
issue presents itself. However, most public sector employers will never achieve total salary competitiveness
if they continue with a short-term approach. Employers focused on pay strategy, however, have a much
better chance to succeed by managing and defining it on their terms. Competitiveness from the perspective
of a pay strategy suggests that the organization prioritize based on both the position and the person.
Higher salaries are directed to those positions most critical to the employer’s operating mission(s) while
also addressing retention of critically skilled employees and those employees performing at high levels.
This approach to pay competitiveness, while unlike the approach typically taken in the public sector, can
be very effective in achieving business results. Paying competitively also does not necessarily mean
paying the market average. Pay strategy focuses on total compensation (salaries and benefits) and ranges
of pay as opposed to specific pay levels to attract and retain employees.
Pay Delivery in the public sector has traditionally been through rigid and inflexible systems. Traditional
pay structures with pre-determined pay steps and timing intervals are still common in many jurisdictions,
and are the most frequently used structure for delivering base salary and salary increases to employees.
High performing organizations are often those that recognize and reward achievement in as many
ways and circumstances as possible. Allowing managers’ greater discretion in pay structure can be very
beneficial in positioning the organization as an “employer of choice.” Public sector employers who are
able to use compensation to attract and retain high performers will experience the most success in the
accomplishment of their business mission.
Pay Practices are the systems an organization uses to deliver pay and pay increases. Pay practices
play an important role in the application of pay strategies in the public sector; from the way a pay
increase is granted (i.e. base pay or lump sum) to increases for special skills, job hazards or geographic
work location. Public jurisdictions can maximize long-term pay strategies by adopting flexible and
innovative pay structures and systems that integrate well with each other and accomplish their purpose.
Communication is an important, but often worst applied component of personnel system change.
Typically, information is shared with employees on a “just in time” basis, and often knowledge is
typically uneven throughout the management structure and messages and timing usually are out of synch.
Developing a strategic approach to communicating your pay strategy helps assure that the right messages
are delivered and received in the right time and in the right manner. A well developed communications

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plan will support an important strategic objective of achieving employee understanding of the organization’s
compensation plan.
Strategic Compensation Alternatives (Choices)
While designing a compensation strategy, several options may be explored by the management .The
major options are discussed below:
Fixed vs. Variable Pay
Traditionally, fixed pay plans have been quite popular in most of the organizations, but now variable
pay programmes are widely followed by many organisations and for all levels of employees. Widespread
use of various incentives plans, team bonuses, profit sharing plans have been implemented with a view
to link growth in compensation to results. Of course, while using variable pay systems, management must
look into two issues carefully:
l Should performance be measured and rewarded based on individual, group or organizational
performance?
l Should the length of time for measuring performance be short –term or long-term?
Internal and External Pay Equity
Most of the compensation systems aim at achieving internal and external pay equity. It may be noted
that pay equity is achieved when the compensation received by an employee is equal to the value of the
work done. Compensation policies are internally equitable when employees believe that the wage rates
for their jobs approximate the job’s worth to organisation . Perceptions of external equity exist when the
firm pays wages that are relatively equal to what other firms are paying for similar types of work.
Job vs. Individual Pay
Many organizations decide the minimum and maximum values of each job independently of individual
workers (who are placed in between these two extremes), ignoring their abilities, potential and the ability
to take up multiple jobs. Such job-based pay systems may, in the end, compel capable employees to leave
the company in frustration. To avoid such unfortunate situations, knowledge-based pay system (or skill-
based ones) have been followed increasingly in many modern organizations. In this case employees are
paid on the basis of the jobs they can handle or the talents they have that can be successfully exploited
in various jobs and situations.
Below Market vs. Above Market Compensation
Small firms having no unions of employees may follow below market compensation. But they will
have to face higher rate of labor turnover. Many large dynamic companies like Infosys, Wipro, TCS, etc.,
pay above market compensation to employees of certain groups in order to attract (and retain) ‘the cream
of the crop’. To grow rapidly and to get ahead of other in race, especially in knowledge- based industries,
leading companies prefer to pay above-market salaries. Above market pay policy is also followed in well
established manufacturing units operating in a highly competitive environment.
Competency Base Pay vs. Broadbanding
A company following a skill-based or competency based pay system may use broadbanding to
structure its compensation payments to employees. Broadbanding simply compresses many traditional
salary grades (say 15 to 20 grades) into a few wide salary bands (three or four grades). By having
relatively few job grades, this approach tries to play down the value of promotions. Depending on
changing market conditions and organizational needs, employees move from one position to another
without raising objectionable questions, (such as when the new grade would be available, what pay
adjustments are made when duties change, etc.). As a result, movement of employees between departments,
divisions and locations becomes smooth. Employees with greater flexibility and broader set of capabilities
can always go in search of jobs in other departments or locations that allow them to use their potential
fully. Broadbanding, further, helps reduce the emphasis on hierarchy and status. However, broadbanding
can be a little unsetting to a new recruit when he is made to roll on various jobs. Most employees still
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believe that the existence of many grades helps them grab promotional opportunities over a period of
time. An organization having fewer grades may be viewed negatively- as having fewer upward promotional
opportunities. Moreover, some of the employees may not want to move across the organization into
different areas.
Strategic Elements of Compensation
T.Flannery etal. (1996) said, “An effective reward strategy can be critical in effectively harnessing
the forces of change and moving the organization forward.”
Accroding to Stredwick, following measures can be taken to design the reward strategies, which will
facilitate the organization to incorporate changes:
1. Achieving Competitive Advantage
- Reward structure can be set at the top of the market range to encourage the best people to join.
Although pay becomes a major expense, this is outweighed by the benefits obtained from
employing the best talents available.Employee retention generally under such strategy remains
high, saving on recruitment cost.
- The strategy of paying high performance premiums to the staff for on-time project completion,
leading to customer satisfaction and repeat business.
- Schemes covering groups or teams of employees such as gain sharing increases their commitment
and involvement and help the teams to work together for the benefit of the organization, its
customers and all the employees.
2. Emphasise Performance
Due to globalization and the resultan increased competition, the proportion of contingent pay, (pay
for performance) has risen compared to base pay. In many organizations, the guaranteed annual increment
has been replaced by an increase based on individual performance.
3. Encourage Flexibility in working practice
The increased movement towards a greater use of flexibility has led to the introduction of rewards
for employees increasing their skills and competencies, which allow them to carry out a wider range of
jobs.
4. Support Key Competencies
Rewards can be used to encourage specific competencies, as for example innovation and creativity.
5. Encourage Local Decision making
Pay decisions used to be made at headquarters but the need to respond to local conditions has led
to decisions on pay being delegated to localized units.

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 LESSON 8

CHALLENGES OF COMPENSATION DESIGN

Dr. Neetu Jain
ADIAS
Institute of Management
People who administer wage and salary face challenges which often necessitate adjustments to a
remuneration plan. The more important of the challenges are skill-based pay, salary reviews, pay secrecy,
Equity or comparable worth, employee participation, elitilism or egalitarianism, below market or above
market rates etc., and monetary versus non –monetary rewards (see Fig.)

Skill-based
Pay

Monetary
Versus Salary
Non-Monetary Reviews
Rewards

Pay
Employee Remuneration Secrecy
Participation

Below Market Eliticism or

or Above Egalitarianism
Market Rates
Comparable
Worth

Fig. Challenges of Remuneration

Comparable Worth
One of the popular principles in employee remuneration is equal pay for equal work. Infact, this
principle has been the inspiration behind the enactment of the Equal Remuneration Act. Under the Act,
male and female nurses are to be paid the same if their merit and seniority match, but a female nurse
and a male electrician could be paid different rates.
Beyond the concept of equal wages for equal wages for equal work, is the idea of comparable worth
which implies that if both a nurse and an electrician receive the same number of points under a point-
ranking method of job evaluation, they have to be paid the same, subject, of course, to seniority and merit
differences.
Any bias in the job-evaluation process is sure to render comparable worth unworkable. Bias is bound
to occur in job evaluations because of the tendency to assign higher number of points for jobs traditionally
held by women.
Employees’ Concern for Equity
Most people in organizations work in order to gain rewards for their efforts. Except in volunteer (non-
profit) organizations, people expect to receive fair value in the form of tangible compensation for their
efforts. Whether considering base pay, variable pay, or benefits, the extent to which employees perceive

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compensation to be fair often affects their performance and how they view their jobs and employers. The
perceived fairness between what a person does and what he receives is known as equity.
Equity is the balance between the inputs an individual brings to a job and the outcomes he or she
receives from it. Employee inputs include experience, education, special skills, efforts and time worked;
outcomes include pay, benefits, achievement, recognition, and any other rewards.
Individuals use a complex process to determine what is fair. Inputs are continuously compared with
outcomes. Since inputs and outputs are in different units, the equity theory suggests that individuals
determine fairness by comparing their outcomes/inputs ratio with the outcomes/inputs ratio of other
individuals. The other person (as group of people) may be in the same job or in other jobs, in the
company or outside the company, in the same industry or outside the industry. A sense of inequity arises
when the comparison process uncovers an imbalance between inputs and outcomes of the employee
compared with others.
Equity theory suggests that individuals will usually make some attempt to relieve the tension created
by any perceived in equity. An employee may take the following recourses (adverse inequity):
- reduced efforts,
- working with colleagues to seek higher pay,
- seeking employment elsewhere, or
- theft.
At times, people notice that they are being overpaid. In such a case, a person:

- might work harder or

- volunteer for an extra assignment.
However, motivation front being overcompensated is relatively short lived. Most individuals quickly
decide that they deserve whatever pay rate they receive and do not try to sustain a higher level of
performance.
Designing Equitable Compensation System
Three elements of equity need to be distinguished: internal, external and individual.
Internal Equity
It refers to the relationship among jobs within a single organization. Among other things, compensation
is presumed to be correlated with the level of knowledge, skill, and experience required to do the job
successfully. Thus no one questions when people high in the organizational structure earn more than
lower level employees so far as such differentials are perceived as fair.
External Equity
It refers to comparisons of similar jobs in different organizations. Some differences are acceptable
as they are considered fair due to variations in size of organizations, location.
Individual Equity.
It refers to comparisons among individuals in the same job on with the same organization. In many
ways, this is the most critical. Efforts to being internal and external equity will get wasted. Suppose the
human resource manager of an organization establishes, through internal and external comparisons that
all administrative assistants in the organization should receive between Rs. 25,000 to Rs. 30,000 per
month. The problem now is to determine the pay rate of each administrative assistant. Should the
company pay more to the existing staff than those who have just been hired? If yes, what is the value
of each additional year of service? Should the difference be based on job performance? If yes, how will
performance be measured? How will the differences in performance be translated into pay differences?
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Employees must perceive that these questions are answered fairly in order for individual equity to exist.
Following exhibit indicates the individual organizational and external dimensions of equity.
Exhibit : Equity considerations in Compensation

External Labour Markets

Competing Employers Policies

Pay Survey Data

Organisational Justice Distributive

Pay For Performance.
Managerial Decisions

Procedural

Policies and Procedures. Pay Structures

Individual
Perception of Inputs and
Outcomes

Establishing Internal Equity

It has been mentioned before that internal equity means that employees receive compensation in
relation to the knowledge, Skill and Abilities (KSAs) they use in their jobs as well as their responsibilities
and accomplishments. Two key issues procedural justice and distributive justice relate to internal equity.
Procedural justice is the perceived fairness of the process and procedures used to make decisions
about employees, including their pay. Employees view procedural fairness in terms of the policies,
procedures and actions of supervisors and managers who implement the policies and procedures. When
applied to compensation, the process of determining base pay for jobs, allocating pay increases and
measuring performance must be perceived as fair.
Distributive justice refers to the perceived fairness in the distribution of outcomes. It examines how
pay relates to performance. If two employees have similar performance record but one receives a
significantly greater pay rise the other may perceive an iniquity due to supervisory favoritism or other
factors not related to the job.
To address the issues of both types of justice, some organizations establish compensation appeal
procedures which are usually formal in public sector organization and informal in private sector
organizations. Typically employees are encouraged to contact the HR department after discussing their
concerns with their immediate supervisors and managers.
By openness, another equity issue concerns the degree of openness or secrecy that organizations
allow regarding their pay systems. A growing number of organizations are opening up their pay systems
to some degree by informing employees of compensation policies providing a general description of the

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compensation system and indicating where is an individual’s pay within a particular pay grade. Such
information allows employees to make more accurate equity comparisons. The crucial element in an open
pay system is that managers are able to explain satisfactorily the pay differences that exist.
Internal equity can established through job evaluation which has been discussed in the earlier chapters.
This chapter will discuss procedures for external equity and individual equity.
Establishing External Equity
Employers need to complete for the skills and knowledge they require to operate their business. In
order to attract, retain and motivate workers with needed skills, an organization must design an externally
competitive pay structures.
The major decision in designing pay structures that conform to equity are:
(1) Specify the employer’s competitive pay policy.
(2) Conduct wage and salary surveys.
(3) Select relevant market competitors
(4) Design the survey.
(5) Interpret survey results and construct market line.
(6) Construct a pay polity live that reflects external pay polity.
(7) Balance competitiveness with internal alignment through the use of ranges of flat rates and bands.
These issues are discussed below:
1. Specify the Employer’s Competitive Pay Level Policy
An organization can follow one of the three options math lead or lag behind the market (discussion
in the chapter on policy).
2. Wage and Salary Survey
A comparison survey can be defined as the systematic process of collecting data and making judgments
about the compensation paid by other employers. An employer conducts and participates in a survey
for a number of reasons:
To Adjust Pay Level to Market Trends: Mostly organizations make adjustments to their pay
structure on a regular basis as response to changes made by competitors. Changes may also be
required due to inflation, performance of employee’s, changes in ability to pay, as per terms specified
in the employment contract.
To Adjust Pay Mix: Though different employees attach different importance to different forms of
pay (base wage stock options, benefits) yet adjustment in pay to overall pay level is required. Perhaps
the high costs of redesigning a different mix create a barrier. Perhaps organizations wish to signal
to the market that what is valued is fairly stable.
To Adjust Pay Structures: The job structure that results from internal job evaluation may not match
competitor’s pay structures in the external market. Reconciling these two pay structures is almost
necessary.
To Study Specific Job Problems: For example, unusual increase in employee turnover in specific
jobs may require focused market surveys to find out if market changes are occurring.
To Estimate Competitors’ Labor Costs: Employers continuously search for ways to squeeze out
more costs and become more productive. They may use salary survey data to benchmark against
competitors product pricing and manufacturing practices.

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3. Select Relevant Market Competitors
Organisations to be covered in a wage survey typically include those that:
(a) employ workers with the same kinds of skill;
(b) are within geographic distances that would make employees willing to commute;
(c) are in the same or similar industry.
The considerations that go into selecting a set of organizations to be surveyed vary for different jobs.
When the survey focuses on wages of common jobs like secretary or truck driver, geographical
considerations gain importance. However in such cases, geographic area is local. For more complex jobs
requiring sophisticated qualifications, the geographic area increases. Competition for managerial,
professional and technical jobs tends to be carried out at the regional, national or, in some instances,
international level. On the other hand, industry is crucial in establishing pay structure for industry specific
jobs, for instance, petroleum engineers.
Sometimes, employees of various organizations within the same geographical area form unions. All
such organizations have to be surveyed.
Still, there is another situation arising now-a-days due to the exclusive use of works being done on
target basis with the help of some persons having different skills working as teams. Further, such jobs
are being designed which require multiple skills to be held by one person.
The new organizations and jobs use together diverse knowledge and experience, so “relevant” markets
appear more like “fuzzy” markets. Organisations with unique jobs and structures have two associated
features:
(a) it is difficult to get comparable market data;
(b) they have to place emphasis on external market data.
4. Design the Survey
It requires answering the following questions:
(a) Who should be involved in the survey design? In most organizations, the responsibility for
managing the survey lies with the compensation manager. But since compensation decisions
have a powerful effect on profitability and performance, managers and other employees and
their teams are used.
(b) How many employers? There are no firm rules on how many employers to include. In a
survey, large firms with a lead policy may exchange data with only a few (6 to 10) top paying
competitors. A small organization in an area dominated by two or three employers may
decide to survey only smaller competitors. National surveys conducted by counseling firms
often include more then 100 employers.
(c) Which jobs to include? A general guideline is to select as few employers and jobs as necessary
to accomplish the purpose. The more complex the survey, the less likely likely other employers
will participate. There are several approaches to select jobs.
Benchmark Job Approach: Benchmark jobs stable job content, are common across different
employees and include sizable numbers of employees. If the purpose of the survey is to price
the entire structure, then benchmark jobs can be selected to include the entire job structure
all functions and all levels, just as in job evaluation.
The degree of match between the survey’s benchmark jobs and each company’s benchmark
jobs is assessed by various means e.g. , installing the same job evaluation programme in all
such companies which participate in the survey or simply asking the participants to judge the
degree of match by using a scale such as: company’s job is of immediately less value ( ), of
slightly less value ( ), of equal value ( ) of slightly more value ( ), of moderately more
value ( ).
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 Low-High Approach: The approach here is to identify the lowest and highest paid benchmark
jobs for the relevant skills in the relevant market and to use the usage for these jobs as
anchors for the skill based structures. Work at various levels within the structure can then be
slotted between the anchors. For example, if the entry market rate for operator A in a skill
based structure is Rs. 20 per hour and the rate for team leader is to Rs. 100 per hour, then
the rate for operator B can be somewhere between Rs. 20 and Rs.100 per hour.
The usefulness of this approach depends on how well the extreme benchmark jobs match the
organization’s work and whether they really tap the entire range of skills.
Benchmark Conversion Approach: It involves application of plan used to create internal
alignment to the description of survey jobs. If an organization uses jobs evaluation, then jobs
evaluation system can be applied to survey jobs. The magnitude of difference between job
evaluation points for internal jobs and survey jobs provides guidance for adjusting the market
data. But it involves again a judgment.
(d) What Information to Collect? Three basic types of data are typically
requested:
(a) information about the nature of the organization;
(b) information about the total compensation system;
(c) specific pay data on each incumbent in the jobs under study
Finally, the data to be collected depend on the purpose of the survey and the jobs and the skills
included.
The information collected about different organizations reflects the similarities and differences among
survey users in term of size sales or revenues. Other information considering the performance of competitors
in terms of earnings per share, market share, employees satisfaction with compensation are not collected.
The information about total compensation data include total pay package and different forms of pay.
(e) What would be the Sources of Data? The main sources of reward information are:
(a) Surveys undertaken by industry associations like All Indian management Association, Federation
of Indian Chambers of Commerce and Industry.
(b) Self Surveys. The organization conducts its own surveys to collect various information about
other organizations.
(c) Government Surveys. The Government of every country conducts organizational surveys to
collect the various information.
(d) Published reports
(e) Survey clubs a graph of organization that regularly exchange information.
(f) Analysis of job advertisements.
5. Interpreting the Data
The greatest challenge of total compensation surveys it to understand how to evaluate the information.
There is no uniform approach for analyzing the results. Every organization uses its our methods of
distilling information from the survey. It uses different survey for different purposes and uses different
methods for company surveys. No commonality is found in the method of analysis by industry by firm
size or by union presence. Some do nothing except data while others put more emphasis on geographic
competitors. Some make comparison with large firms while other completely eliminates large firms.
This diversity reflects flexibility in dealing with a variety of circumstances. At the same time it
reflects expediency and a lack of business and work related logic.
Before interpreting data, it is necessary to verify the data for accuracy of the job matchesfor weeding
out anomalies
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 The next step is to analyse data statistically by preparing frequency distribution calculating averages
and degree of variation.
Because, the data gathered reflect decisions of employers, employees, unions and government agencies,
wages paid by competitors change constantly. If a survey that requires three months to collect, code and
analyze, is probably outdated before it is available. Therefore, the pay data are usually updated (a process
often called aging or trending) to forecast the competitive rates for the future date when pay decisions
will be implemented. Even though such changes do not occur smoothly and uniformly throughout the
year, for practical purposes it is assumed that they do.
The amount of update is based on several factors, including historical trends in the labor market,
prospects for the economy in which the employees operates and the manager’s judgment, labour wage
indices, among others.
6. Establish Pay Rates
After survey results have been studied, the next step is to merge the results of job evaluation with
such results in order to determine pay rates for each class of job. Further consideration of the pay level
policy(step 1) is required to be done.
Establishing Individual Equity
Individual equity requires that rewards to employees be allocated fairly across individuals performing
the same job. Once managers have determined pay ranges, they can set the pay for specific individuals.
Setting a range for each pay grade gives flexibility by allowing individuals to progress within a grade.
A pay range also allows managers to reward the better performing employees while maintaining the
integrity of the pay system.
Rates Out of Range
Regardless of how well constructed a pay structure is, usually there are a few individuals whose pay
is lower than minimum or higher than the maximum. This situation occurs most frequently when firms
that have had an informed pay system develop a new, more formalized one.
Red Circled Employees are incumbents whose current pay amounts are more than the range set for
the job. Over time management would attempt to bring down such amount by:
(a) cutting the pay of such employees (seldom used);
(b) freezing employee’s pay until the pay range can be adjusted upward to get the employee’s pay
rate back into the grade;
(c) giving the employee a small lumpsum payment but not adjust the pay rate when others are given
raises.
Green Circled Employees are those whose pay is below the range. These employees receive fairly
rapid pay increases.
Pay Compression
It is situation when the pay differences among individuals with different levels of experience and
performance becomes small. Such situations are prevalent in many occupational areas such as the
information technology. In this case, current employees may be getting less salary than paid to new
analyst from outside with less experience. One partial solution to pay compression is to have employees
follow a set progression based on length of service; assuring performance is satisfactory or better.
Issues Involving Determination of Pay and its Increases
There are several ways to determine pay and necessary increases.
1. Pay for Performance (Merit Pay)
It links increases in base pay called merit increases to how highly employees are rated on a subjective
performance evaluation. The following illustration clarifies its working:

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Performance Well above Above Average Below Well-below
rating average average average average

Merit Pay 1 2 3 4 5
increase 6% 5% 4% 3% 0%

Ian Kessler linked type of performance with unit of performance as given in following table. Though
merit pay is designed to enhance employee and corporate performance, it does not happen so always as
the performance appraisals remain subjective. Therefore, the following procedure is suggested to improve
the objectivity of such appraisals.
Table: Pay systems: Linking Type of Performance with Unit of Performance
(Source:Ian Kessler in John Storey (p. 209)

Type of Performance Unit of Performance

Individual Collective

Input Piece Work Measured Day Work

Commission Team Pay
Individual Bonus Profit Sharing
Individual Performance Gain sharing
Skill—Based Pay Employee Share
Merit Pay Ownership
Competence Schemes

The steps in goal setting approach are as follows:

2. Identify an employee’s key job tasks: The best source for this information is each employee’s
job description.
3. Establish specific and challenging goals for each key task and identify the level of performance
excepted of each employee. Putting deadlines on each goals reduces ambiguity. Deadlines,
however, should not be set arbitrarily. Rather they need to be realistic given the tasks to be
completed.
4. Allow the employee to actively participate.
5. Prioritize goals. If the employee has more than one goal to achieve, he should be encouraged
to prioritize them. Goals should be rated in terms of difficulty and importance. Individuals can
be given credit for trying difficult goals even if they don’t fully achieve them. This will
discourage people from choosing easy goals.

6. Build in feedback mechanism to assess goal progress. Feedback lets employee know whether
their level efforts is sufficient to attain the goal. Feedback should be both self-and
superior- generated. In either case feedback should be frequent and recurring.
7. Link rewards to goal attainment. It’s natural for employees to ask “what is in it for me?”
Linking rewards to the achievement of goals will help answer that question.
Variable pay plans, incentive plans, compensation at risk, earnings at risk, success sharing are
few such names which are used interchangeably with pay-for-performance. Though they are not
similar in all respects, the major thing they have in common is a shift in thinking about

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 compensation. Pay used to be thought as an entitlement for membership. Pay for performance
plans move away from entitlement and link pay with individual or organizational performance.
Earlier pay for performance used to be compensation tool for top management but now it is gradually
becoming prevalent among lower level employees too. There can be two reasons for this:
(1) Increasing competition forces organization to cut costs and increase productivity.
(2) Business environment is changing fast. It requires workers to adjust and adopt new ways of
working at a very fast face. If this is not done, market share goes to competitors; business closes
down and workers become jobless. So compensation experts are thinking of designing such
reward system that link workers’ interest with the objectives of the company.
However merit pay is increasingly under attack and it needs to be managed better. It requires:
(1) improving the accuracy of performing ratings;
(2) making sure the size of the merit increase differentiates across performance levels reasonably
enough.
Lump-sum-bonus given at the end of the year is considered more of merit pay than entitlement pay.
2. Efforts
Though, it is not an explicit way of rewarding efforts, it is still a major determinant in the reward
distribution. The rewarding of efforts represents the classical example of rewarding means rather than
ends. The employee who is clearly perceived by his supervisors to be working less than some other
employee who may be providing less but, is giving out a greater efforts. Even where it is clearly stated
that only performance will be rewarded, those who evaluate and distribute awards are only human.
Therefore, they are not immense to showing compassion for those who try hard, but get little success.
This feeling affects their evaluation and reward decisions.
3. Seniority
Seniority or tenure dominates civil (Government) service system in most of the democratic economies
of the world. Though they do not play that important role in business organizations, still it remains a
major factors in determining the allocation of rewards.
Seniority’s greatest virtue, in relation to other criteria, is that it is easy to determine. There may be
disagreement as to whether, A’s work is better or B’s work is better, but there will not be much disagreement
as to who had been in the organization longer.
4. Skill Held
When individuals enter an organization, their skill level is usually a major determinant of the
compensation they will receive. In this case, the market place or competition has acted to make skill a
major element in the reward package. Therefore, the relationship of demand and supply for particular
skills in the community can significantly influence the rewards the organization must expand to acquire
particular skills. That is why professionally qualified people, certified chartered accountant, doctor’s
engineers, command higher pay package than those who are averagely qualified.
Therefore, skills possessed at the time of the entry and skills improved during stay are a major determinant
of rewards irrespective of the fact whether those skills are used or not.
5. Job Difficulty
The complexity of the job can be a criterion by which rewards are distributed. For example, those
jobs that are highly repetitive and can be learned quickly may be viewed less deserving in rewards than
those that are more complex and sophisticated. Jobs that are difficult to perform, or are undesirable due
to stress or unpleasant working conditions may have to carry with them higher rewards in order to attract
workers.

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6. Discretionary Time
The greater the discretion called for on a job, all other things being equal the greater the impact of
mistakes, and the greater the need for good judgment. In a job that has been completely programmed that
is, where each step has been procedurised and there is no room for decision making of the incumbent
there is little discretionary time. Such jobs require less judgment and rewards can be offered to attract
people to take such positions.
As discretion time increases, greater judgment abilities are needed and rewards must commensurately
be expanded.
The above discussion suggests that there are a number of determinants by which rewards can be
allocated, though two main ones being performance and seniority.
Quite frequently a contradiction exits between what an organization says it rewards and what workers
perceives is being rewarded. The manager who continually assures workers that suggestion for doing their
job are encouragement, yet ridicules any and all suggestions impresses upon his subordinates by his
behaviour that the does not reward suggestions at all.
Compensation System Design Issues
Compensation must be viewed strategically as a lot of organizational funds are spent on compensation
related activities. Organizations must make a number of important decisions about the nature of a
compensation system. According to Mathis, such decisions include:
(a) What philosophy and approach will be taken?
(b) How will the firm react to market pay levels?
(c) Will the job be paid on the person’s level of competence?
(d) Will pay be individual or team based?
Compensation Philosophies
The two basic compensation philosophies lies on opposite ends of a continuum. At one end of the
continuum is the entitlement philosophy and at the other end is the performance oriented philosophy.
Most compensation systems fall somewhere in between.
Entitlement Orientation
Many traditional organizations that give automatic increases to their employees every year practice
the entitlement philosophy. Further most of those employees receive the same or nearly the same percentage
increase each year. Entitlement philosophy is practiced by employees and managers under belief that
individuals who have worked for a year are entitled to a raise in base pay. They also believe all incentives
and benefit programmes should continue and be increased regardless of changing industry or economic
conditions. Commonly, under this philosophy, pay increases are referred to as cost-of –living raises, even
if they are not tied specifically to economic indicators. Following this philosophy means that as employees
continue their employment lives,employer costs increases regardless of employee performance or
organisational competitive pressures. Market comparisons tend to be made within an industry, rather than
more broadly considering compensation in firms of all types. Bonuses in many entitlement oriented
organizations are determined in a paternalist manner that often fails to reflect operating results. Therefore
employees expect the year end bonus, which is another form of entitlement.
Range of Compensation Approaches
The three main goals of compensation management i.e recruiting, motivating, and retaining good
people have not changed much over time, but the ways in which some companies approach them differ
dramatically from previous approaches. Performance –based pay, tailored to the strategic circumstances
of each organization, may consist of base pay, an annual bonus, a choice of various other benefits. This
is known as “total rewards” package.
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Traditional Compensation Approach
For some organizations, a traditional compensation approach makes sense and offers certain advantages
in specific competitive situations. It may be less complex, and viewed as more “fair” by average and
below average employees. It reflects a logical, rational approach to compensating employees.
Total Rewards Approach
It tries to place a value on individuals rather than just the jobs; widespread use of various incentive
plans, team bonuses, organizational gain sharing programmes, and other designs serves to link growth in
compensation to results. However, management must address the following two main issues when using
variable pay systems:
l Should performance be measured and rewarded based on individual, group, or organizational
performance?
l Should the length of time for measuring performance be short term (less than one year) or longer
term (more than one year).
Competency Based Pay
Skill-based pay In the traditional job-based pay, employees are paid on the bases of job they do. In the
skill-n based system, workers are paid on the basis of number of jobs they arte capable of doing, or on
the depth of their knowledge. The purpose of this system is to motivate employees to acquire additional
skills so that they become more useful to the organization. Following table compares skill-based pay with
job-based remuneration.
Table : Skill-based pay and job-based pay compared
Factors Job-based Skill-based
Pay structure’s focus Based on job performance Based on ability to perform
Employer’s focus Job carries; Employee Employee carries wage;
linked to job Employee linked to skills
Employee focus Job promotion to earn Skill acquisition to earn
greater play grater pay
Procedures required Assess job content; Value Assess skills; Value skills
jobs
Advantages Pay based on value of work Flexibility; Reduced
performed workforce
Disadvantages Potential personnel Potential personnel
bureaucracy; Inflexibility bureaucracies;
Cost controls.
Skill-based pay systems work when the following conditions exist:
1. A supportive HRM philosophy underpins all employment activities. Such a philosophy is
characterized by mutual trust and the conviction that employees have the ability and motivation
to perform well.
2. Other programmes such as profit sharing, participative management, empowerment, and job
enrichment complement the skill-based pay system.
3. Technology and organizational structure change frequently.
4. There are opportunities to learn new skills.
5. Employee turnover is relatively high.
6. Workers value teamwork and opportunity to participate.

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 Under this approach employees receive more for doing jobs that require a greater variety of tasks ,
more knowledge and skills, greater physical efforts, or more demanding working situations. However, a
number of organizations pay employees for the competencies they demonstrate rather than just for the
specific tasks performed. In a Knowledge Based Pay (KBP) or Skill Based Pay (SBP) system, employees
start at the base level of pay and receive increases as they learn to do other jobs or gain other skills and
therefore become more valuable to the employer.
This approach places far more emphasis on training employees and supervisors. Also workflow must
be adapted to allow workers to move from job to job as needed.
The working of competency based system needs to acknowledge or certify employees as they acquire
certain competencies, and to verify the main tenure of those competencies. This approach has been quite
popular in knowledge based organizations like “3M” which offer reward for excellent performance and
innovation.
Individual vs Team Rewards
In the present times, organizations are shifting from individual (superior subordinate relationship)
responsibility towards team-work. The logical problem arises is how to compensate the individual whose
performance may also be evaluate on the basis of team achievement. If every member of the team is paid
the same amount, the equity concerns are bound to arise as the contribution of each to team’s performance
is bound to be different. The following guidelines can be followed when using team based reward
systems:
l Use skill-based pay for the base pay for each individual.
l Make the system simple and understandable.
l Use variable pay based on business entity performance.
l Distribute variable rewards at the team level.
l Maintain a high degree of employee involvement.
In short, individual based pay can be determined on the basis of competence, and variable pay for
team performance can be distributed annually as a specified amount not as a percentage of base pay. This
approach has been found to be quite successful.
Open vs. Secret Pay
This is a very controversial issue in compensation management. The Process by which a remuneration
plan is designed and administered is critical for any organization. One challenge facing HRM concerns
the availability of information about remuneration to employees. The tendency among most firms is to
maintain pay secrecy as this would help avoid pay comparisons likely to be made by employees.
‘Just how much and what types of information about pay should be provided to employees is a
question that troubles HR managers. This is a difficult question to answer. Much has been written about
the effects of pay secrecy on employee behaviors and attitudes.
Firms in the organized sector and public sector enterprises disclose full information about wages and
salaries. Most firms, particularly family-controlled organizations tilt towards maintaining pay secrecy.
For merit pay systems to have a motivating effect, an employee needs to know how efforts translate
into rewards. Information about maximum and the average raises should be made available each year.
Each employee should be told ‘what the mid point is’ for his or her job, as well as the pay range. In
addition, the organization should explain how it arrived at arrived at the pay structure. Allowing employees
to see ‘where their jobs are located in the wage structure’ should not create significant problems for and
employer that has a well-designed job evaluation plan.
It is now widely believed that pay openness is likely to be more successful in organizations with
extensive employee involvement and an egalitarian culture that encourages trust and commitment.

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 Open pay eliminates doubts in the minds of employees regarding pay equity and fairness. But open
pay has some problems also. First, managers are forced to defend their compensation decisions publicly.
The question of how much pay one should get is more or less decided by the manager-based on his own
subjective assessment of various factors. In such a decision, it is not easy to please everyone. Second,
the cost of making a mistake in a pay decision increases when pay is open. Third, to avoid never-ending
and time-wasting arguments with employees, managers may eliminate pay differences among subordinates
despite differences in performance levels. This may, in the end, force talented employees to leave the
organization.
Pay secrecy involves withholding information from the employees regarding how much other make,
what raises others have received and even what pay grades and ranges exist within an organization. Pay
secrecy gives managers some amount of freedom in compensation management, since pay decisions are
not disclosed and there is no need to justify or defend them. Employees who do not know how much
others are getting have no objective base for pursuing complaints about their own pay. Pay secrecy
surrounding compensation decisions may lead employees to believe that there is no direct relationship
between pay and performance.
Pay secrecy is a difficult policy to maintain because most of the pay related information is now
available on the web. Anyone with access to the Internet can easily find out what a position is worth in
the job market.
Pay Reviews pay
Pay once determined, should not remain constant. It must be reviewed and changed often, but how
often becomes a relevant question,. Pay reviews may be made on predetermined dates,Anniversary
dates or there could be flexible reviews. In the fixed-date reviews, wages and salaries of all employees
are reviewed and raised one specified date each year. In the anniversary-sate review, salaries may be
reviewed at twelve-month intervals from the date of the employee’s anniversary date of hire. Using
variable timing ensures flexibility. In addition, high-performing employees, who are low on their
salary ranges, can be rewarded more frequently.
In organized industrial establishments, pay review take place once in three years. Managements enter
into wage and salary agreements with labour unions and the agreement will be valid for three years.
Pays negotiations will take place on the expiry of the three-year period and new records are signed
after conclusion of the talks.
In government departments, pay revisions take place once in ten or fifteen years. Revision will
depends on the recommendations of the Pay Commission.
Employee Participation
When employees are involved in designing a remuneration plan, they exhibit little resistance in
accepting it. Such a plan is much more likely to be a successful motivator than the one imposed by the
management.
It is appropriate to involve employees in many phases of a reward system. For example, a wide
variety of employees should serve in job evaluation committees. If a point-ranking method is adopted,
it is reasonable to involve employees in identifying the compensable factors to be used and the weight
to be assigned to each factor. Employees are also likely to have a good insight in identifying competitor
firms that should be included in a wage survey.
There are several mechanisms for employee involvement. At the broadest level the employees can
be surveyed to learn about their preferences. Employee task forces can help integrate these preferences
into a system. Such groups are usually an excellent way to involve employees in any decision associated
with a reward system.
The decision to involve employees in designing or administrating a remuneration plan should not be
made in haste. Employee participation is unlikely to work well unless the organization has already

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established an overall philosophy of participative management, as well as a reasonable climate of
organizational trust. Participation takes considerable time – if time and trust are limited, a more traditional,
a top—down approach might be more appropriate.
Eliticism Vs. Egalitarianism
Firms become egalitarian when they place most of their employees under the same remuneration
plan. The plan becomes elitist when the organizations establish different remuneration schemes. In some
firms only CEO is eligible for stock options. In others, even the lowest paid workers are offered stock
options. In some other companies only one category of employees is offered incentive schemes but in
others all employees are covered by pay-for-performance schemes.
Egalitarianism gives organizations more flexibility to deploy employees in different areas without
having to change their pay levels. It can also reduce barriers between people who need to work together.
Egalitarian remuneration systems are found mainly in highly competitive environments where companies
frequently take business risks and try to expand their market share by continually investing in new
technologies, ventures and products.
Elitist remuneration systems are prevalent among older, well-established firms with mature products,
a relatively stable market share and limited competition. Elitist pay structures tend to result in more stable
work-force because employees make more money only by moving up through the company.
Below Market Vs. Above Market Remuneration
Remuneration involving decision relating to below market or above market pay structure has two
implications. First, a firm’s ability to attract talent from others depends on employee’s pay relative to
alternative employment opportunities. Second, the choice has an important cost component. Decision to
provide above market rate obviously adds to the cost. However in general, above market pay policies are
more prevalent among larger companies in less competitive industries, such as utilities and among
companies that have been performing well and have the ability to pay more. In addition, companies
desirous of growing fast in a tight labour market need to pay above market rates. Unionised firms also
need to pay higher rates.
Firms paying below market rates tend to be small and disorganized. Garment units, beedi rolling and
incense- sticks rolling firms pay wages that do not come anywhere near current rates.
Monetary Vs. Non-monetary Rewards
The issue relating to monetary and non-monetary rewards has primarily tax implications. Many non-
monetary rewards such as medial benefits and housing are fully or partially exempted from taxes.
Employers and even employees prefer non-monetary benefits than monetary rewards.
Broadbanding
In a broadbanded pay structure, combinations of job classifications are grouped into pay bands. This
system differs from a conventional grading system because of the greater pay range within each band and
the smaller number of bands. Pay progression through each band is normally related to employee
competency, performance, contribution or market rates of pay. Broadbanding is often introduced as a
means of enabling an organization to comprehensively redesign its salary structure.
Broad banding involves several steps. First, you need to decide on the number of bands and how
many points they will include, and assign each band a salary range. The bands usually have wide salary
ranges and overlap substantially. A band may consist of a number of jobs, each with a market wage rate.
More often, bands contain several skill levels. Workers must increase their skills and knowledge to get
raises.
Most firms end up with pay plans that slot jobs into classes or grades, each with its own vertical pay
rate range.The question is, “How wide should the salary grades be, in terms of the number of job
evaluation points they include?” There is a downside to having narrow grades. For instance, if you want
someone whose job is in grade 2 to fill in for a time in job that happens to be in grade 1, it’s difficult

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to reassign that person without lowering his or her salary. Similarly, if you want the person to learn about
a job that happens to be in grade 3, the employee might object to the reassignment without a corresponding
raise to grade 3 pay. Traditional grade3 pay plans thus breed inflexibility.
That is why some firms are broad banding their pay plans.
Broadbanding means collapsing salary grades and ranges into just a few wide levels or bands, each
of which contains a relatively wide range of jobs and salary levels. Following figure illustrates this. In
this case the company’s several previous pay grades are consolidated into two broad bands.
A company may create broadband for all its jobs, or for specific groups such as managers or
professionals. The pay rate range of each broadband is relatively large, since it ranges from the minimum
pay of the lowest grade the firm merged into the broadband up to the maximum pay of the highest merged
grade the firm merged into the broadband up to the minimum pay of the lowest merged grade. Thus for
example, instead of having 10 salary grades, each of which contains a salary range of Rs 15,000, the
firm might collapse the 10 grades into three broad bands, each with a se t of jobs such that the difference
between the lowest- and highest-paid jobs might be Rs 40,000 or more. For the jobs that fall in this
broadband, there is therefore a much wider range of pay rates. You can move employees form job to job
within the broadband more easily, without worrying about the employees moving outside the relatively
narrow rate range associated with a traditional narrow pay grade. Broad banding therefore breeds flexibility.
Companies broadband for several reasons, most often to support strategic performance improvement
initiatives. Broad banding’s basic advantage is that it injects greater flexibility into employee assignments.
It is especially sensible where firms flatten their hierarchies and organize into self-managing teams. The
new, broad salary bands can include both supervisors and subordinates and also facilitate moving employees
slightly up or down along the pay scale, without bumping the person into a new salary range. For
example, “the employee who needs to spend time in a lower-level job to develop a certain skill set can
receive higher- than –usual pay for the work, a circumstance considered impossible under traditional pay
systems.” One expert argues that traditional quantitative evaluation plans actually reward inadaptability.
He argues that jobs narrowly defined by compensable factors such as “know-how” are unlikely to
encourage job incumbents to be flexible. Instead, the tendency may be for workers to take “that’s not my
job” attitude and to concentrate on their specific tasks.

Band B
Wages Rates. Rupees

Band A

Grades and Evaluated Points

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 However, broad banding can be unsettling, particularly for new employees. For example, Home
Depot has used broad banding for over 10 years, and “ when employees wants to learn something new,
they play to the level [on that project] that they’re capable of ,” says the firm’s head of information
systems. That is motivating once you get used to it. However, it can make a new employee feel adrift:”
There’s a sense of permanence in the set of job responsibilities often attached to job titles,” he says. That
sense of permanence isn’t nearly as clear when employees can (and are expected to) move frequently
from project to project and job to job.
A survey of 783 employers found that about 15% were using broad banding. Usually companies do
so to support its strategy of cutting costs and flattening and downsizing the organization. The flattening
meant fewer jobs, each of which had broader responsibilities, and broad banding made it easier to get
employees to assume their new, broader roles. Dow Jones & Company implemented broad banding for
its 1,000 IT professionals several years ago.
Even with trends like competence/skill-based pay and broad banding, 60% to 70% of U.S firms use
point and factor comparisons plans. Job evaluation’s relative ease of use and familiarity are probably the
main reason. And neither skill-based pay nor broad banding eliminates the need for evaluation the worth
of one job relative to others.
Designing a Broadbanded Structure
Armstrong et al. suggests taking of the following steps for designing a broadbanded structure:
(1) Decide on objectives: A compensation structures can be set out for different objectives like
increase flexibility in the provision of rewards, reflect organization structure, provide a better
base for regarding lateral or diagonal development and growth in competence, or replace an
over complex and inappropriate grade and pay structure.
(2) Decide on number of bands: The decision on the number of bands will be based on an analysis
of the existing organization structure and hierarchy of jobs. Initially, some number is decided
which can changed after more detailed work in the next two stages.
For e.g. , and organization may decide to have six tiers-(1) Senior managers, (2) middle
managers, (3) first line managers and senior specialists, (4) team leaders and specialists, (5)
senior administrators and support staff, and (6) administrators and support staff.
(3) Decide on Band Infrastructure: A decision has to be made at this stage on the use of reference
points and zones. Reference point mean normal rate for a job (determined according to job
evaluation) aligned to market rates. Ranges for pay progression may be built round the reference
points and these are known as ‘zones’. The method of determining reference points, width of
the zones and the basis upon which people should progress within and between zones. The
scope for flexibility in creating special reference points and zones for individuals should also
be considered.
(4) Define the Bands: Broad initial definitions are now made of each of the bands.
(5) Prepare role profile for benchmark jobs. Identify benchmark jobs that are representative of
different functions at the levels covered by the structure and or which market price data can
probably be obtained. They should include as many of the key generic roles as possible. Role
profiles for each of them are then prepared. The profiles should provide sufficient information
to enable them to the matched with the band definitions and, ideally, for market comparisons.
(6) Match the benchmark roles to the bands. The matching process should provisionally allocate
each benchmark role to a band. It is best carried out by a team consisting of line managers and
employee representatives facilitated by HR or an outside consultant. This initial matching may
indicate that the bands need to be redefined.
(7) Obtain market prices of the benchmark roles.
(8) Evaluate benchmark roles using job evaluation method.

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 (9) Decide on reference points by striking a balance between job evaluation results and market
information.
(10) Decide on zones in accordance with policy determined at step 3.
(11) Define pay ranges of bands in accordance with reference points and zones. The range
of pay for a band will be the range of pay from the bottom of the lowest zone to the
top of the highest zone.
(12) Define bands in terms of job evaluation scores.
(13) Allocate non-benchmark roles to bands. In theory, the remaining non-benchmark jobs could be
allocated to bands on the basis of job evaluation, but in practice most organizations match role
profiles for such jobs (which are often generic) with the profiles of benchmark jobs.
(14) Communicate outcomes. Staff should have been involved and kept informed of the progress of
the design process throughout the exercise but in this final stage the way in which broadbanding
works and how it will affect them must be explained in detail.
Advantages of Broadbanding
The advantages of broadbanding are discussed below:
(i) Broadbands provide flexibility to define job responsibilities and fix pay more broadly. Flexibility
means wide scope given by broad banding; (a) to adapt rates of pay more readily to market rate
increases; (b) to reward lateral career development without being restricted to rigid grades. It
encourages employees to move cross functionally to increase cross fertilization of ideas. Hence,
career moves within bands are more common than between bands.
(ii) It also reduces the costs of implementing a new pay structure because more jobs will be
incorporated in the bands, with less need to increase the pay for those in jobs that might be
placed below the new pay ranges in a structure with narrower grades.
(iii) It provides a role-specific and performance management focus on reward.
(iv) It dismantles the overly structured and bureaucratic approach of typical multi-graded structures,
and
(v) It can reduce the time spent on analyzing and evaluating jobs because there are are fewer levels
between which such distinctions need to be drawn.
(vi) It enables an employee to focus on the content of the job, its challenges and its developmental
opportunities rather than worrying about grade level. So,the employee can earn new skills and
better contribute to the team without the possible stigma of a demotion or reduction in pay.
Disadvantages of Broadbanding
The advantages of broad banding may look convincing but there are a number of formidable
disadvantages, some of them general and others related to equal pay considerations:
(1) General Problem
It has been found that broad banded structures are harder to manage than narrow graded structures
in spite of the original claim that they would be easier. Managers must be trained to deal with banding’s
broader salary ranges and fewer control points.
1. They make considerable demands on line managers as well as HR, notably in the areas of
performance management and communication.
2. Broad banding can build employee expectations of significant pay opportunities that get doomed
in many cases if proper control of the system is maintained.
3. It can be difficult to explain to people how broad bending works and how they will be affected.

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 4. Flexibility, considered to be the main pay-off of broad banding, may result in chaos and
favoritism.
5. It may result in increased labour costs.
6. It may leave the organization “vulnerable” to inconsistent or practices.
7. Decision on movements within bands can be harder to justify objectively than in other types
of grade and pay structures.
8. Employees may be concerned by the apparent lack of structure and precision and they may not
trust their managers to operate the policy consistently.
9. Workers may resist the absence of frequent, even if small, symbols of their increased value
through movement to higher grades.
(2) Equal Pay Problems
1. Reliance on external relativities (market rates) to place jobs in bands can reproduce existing
inequalities in the labour market.
2. The broad pay ranges within bands mean that they include jobs of widely different values or
sizes, which may result in gender discrimination.
3. Women may be assimilated at their present rates in the lower regions of bands and find
impossible or at least very difficult to catch up with their male colleagues who because of
longer, unbroken service and their existing higher rates of pay are assimilated in the upper
reaches of bands.
Precautions in Implementation of Broadbanding
Because of the objections to broadbanding from an equal pay perspective greater attention is being
paid to placing jobs in bands on the basis of internal relativities. Market rates are still taken into account
but policy guidelines emphasize that the organization should be sensitive to market rates rather than being
driven by them and should be aware of the danger of reproducing external discriminatory practices.
A further problem with broadbanding is that the introduction of bands within bands, i.e. , zones,
prompts the question: what is the difference between a broadbanded structure with four bands, each with
three zones, and a conventional graded structure with 12 grades. The answer is that ranges traditionally
serve as controls, whereas reference rates act as guides, zones operate more flexibly with regard to
grading, pay progression and reaction to market pressures. But skepticism about the broadbanding concept
in its original form in increasing.

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 LESSON 9
COMPENSATION POLICIES IN INDIA
Dr. Neetu Jain
ADIAS
Institute of Management
Introduction
In any country, the wage policy is a complex and sensitive area of public policy because of its impact
on the status of working class in the society, its commitment to the industry and the attitudes towards
management. In the modem industrial system, wages form the pivot around which most of the problems
revolves. Wage issues are often prominent in collective bargaining and represent a frequent cause of
grievances and industrial disputes. Dissatisfaction with wage rates is one of the most common causes of
low level of production, efficiency and morale.
The present chapter discusses compensation policies in India under the following heads:
(1) Wage policy before Independence.
(2) Wage policy after Independence.
Wage Policy Before Independence
The British Government followed the policy of laissez faire towards wage problems for quite a long
time. The origin of settlement of wages through third party intervention can be traced to 1918 when at
the initiative of Mahatma Gandhi; a wage settlement took place in Ahmedabad. After that, the following
Acts were passed:
l Workmen’s Compensation Act, 1923.
l Trade Unions Act, 1926.
l Payment of Wages Act, 1936.
l Industrial Truce Resolution, 1947.
l Industrial Disputes Act, 1947.
The Workmen’s Compensation Act, 1923
It aims at providing social security to workmen. Under this Act, an employer is liable to compensate
the employee for any injury caused to him by accident arising out of and in the course of his employment
unless
l Injury does not result in total or partial disablement of worker for a period exceeding three days;
l Injury caused by an accident directly attributable to;
- workman under influence of drinks or drugs
- Willful disobedience of express orders for safety.
- Willful removal of safety guard or device.
An employer is liable to pay if an employee gets affected by any specified occupational disease,
While he is in the service of employer for at least six months.
The Act applies even if the organization employs just one worker, and the organization need not be
covered under the Factories Act.
Though the term ‘workman’ includes any worker doing any of the wide varieties of jobs, it does not
include clerical staff under its purview,
Compensation is payable to injured workman, and in the event of his death to his dependents.
If a worker claims compensation under this Act, he cannot file a civil suit against employer for
damages. Similarly, a worker covered under ESI Act is not entitled to get compensation under this Act.

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 Amount of compensation Payable under the Act in case of death is: Rs. 80,000 or an amount equal
to fifty percent of the monthly wages of the deceased workman multiplied by the relevant factor, whichever
is less. In case of permanent total disablement, Rs. 90,000 or 60% of the monthly wages of the disabled
workman multiplied by the relevant factor.
Relevant factor in the above cases is number of completed years of age of the workman on his last
birthday immediately preceding the date on which compensation fell due.
In case of temporary disablement total or partial 25% of monthly wages are payable on half monthly
basis. A Commissioner for Workmen’s compensation is appointed by the Government, all the compensation
payment in case of death and total disablement should be paid paid through him.
Expenditure incurred by the employer for medical treatment of workman is not considered for
purposes of the compensation.
The Trade Union act, 1926
It aims at defining law relating to registration/working of Trade Unions. According to it, any seven
or more members of Trade Union can apply for registration to the Registrar of Trade Unions appointed
for each State, along with a copy of trade union’s rule and other required details. Registrar shall register
Trade Union and enter particulars in the register maintained by him.
On registration, a trade union acquires all the features of a body corporate. However, registration does
not mean recognition, as the latter indicates a matter of agreement between employer and trade union.
The Payment of Wages Act 1936
The Act applies to payment of wages to workmen employed in
a) factory as defined in section 2(m) of the Factories, Act;
b) railways; and
c) industrial or other establishment as per Section 2 (ii)
Presently the Act extends to the whole of India and to the employees drawing wages upto Rs. 1,600.
The limit is being increased to Rs. 6,500 by amending the Act.
Wages can be paid on daily, weekly, fortnightly or at the monthly basis. Wages should be paid on
a working day. Wages are payable on or before 7th day after the wage period. In case of factories
employing more than 1000 workers, wages can be paid on or before the 10th day after “wage period”
is over.
Deduction on account of absence of duty, fines, house accommodation and many more such benefits
and facilities can be deducted. Maximum deduction can be 50% (75% if deduction is partly made for
payment to cooperative society). Fine can be imposed only after giving a personal hearing to the employee.
This Act was a result of the report of the whitely commission which specifically stressed the need for
preventing unfair deductions besides dealing with issues like minimum wages, standardization of wages
and incentives; and intersectoral wages.
The government initiated its active intervention on all India basis only during World war II by
allowing additional payment of dearness allowance for rise in prices and share in war-time increased
productivity. However Rege Committee felt that such short term measure without a scientific attitude
could be damaging both to the workers and the industry.
The Programme of 1946
It stressed the following three elements of wage policy:
l the statutory prescription of minimum wages in sweated industries and occupations in agriculture.
l Promotion of fair wage agreements; and
l Steps to secure for workers in plantations, a living wage (it amounted to minimum wages that
time).
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The Industrial Disputes Act, 1947
The act provides machinery for settlement of disputes, if it cannot be solved through collective
bargaining. It also provides for certain other provisions in respect of lay-off, retrenchment, closure etc.
The Act defines industry, industrial dispute, and workmen.
Adjudication of disputes. The Act provides for ‘Works Committee’ in factories employing 100 or
more workers. The committee will consists of equal number of representatives of employer and employees.
Representatives of employees will be selected in consultation with the Registered Trade Union. The
Works Committee will first try to settle disputes. If dispute is not solved, it will be referred to ‘Conciliation
Officer’ who is appointed by the Government. He will try to arrive at fair and amicable settlement. If
he is unable to do so, he will send report to appropriate Government who may then refer it to the Board
of Conciliation, Labour Court or Industrial Tribunal or National Tribunal.
Industrial Employment (Standing Orders) Act, 1946
It has been designed to provide service rules to workmen. Out of many standing orders, one is
relation to subsistence allowance. According to this rule, where a workman is suspended by employer
pending investigation or enquiry into complaints or charges of misconduct against him, the workman
shall be paid subsistence allowance equal to 50% wages for first 90 days of suspense and 75% of wages
for remaining period till completion of disciplinary proceeding.
Wage Policy After Independence
As a welfare state, India is committed to secure for its working population, social and economic
justice which can be achieved through the formulation of a sound national wage policy in consonance
with the Directive Principles of State policy enunciated in the Constitution of India. Art.39 of the
constitution of provides the principle of equal pay for equal work for both men and women, and Art. 43
provide as a directive principle of state policy that the state must Endeavour to secure for all workers
a living wage and conditions of work which ensure a decent standard of life as well as full enjoyment
of leisure and social and cultural opportunities.
Objectives of National Wage Policy
The aim of national wage of policy in India is to ensure an income level for the workers by which
they can maintain a decent standard of living. By and large, the people in India are poor. It must be
recognized that poverty constitutes a great threat to democracy. So the wage policy in any country should
be rational and based on social and economic considerations. The national policy should ensure that
people are not compelled to work at unreasonable low level of wages and to live a life at sub- human
levels of existence because of lack of effective organization and bargaining power.
The basic purpose of the national wage policy is to improve the economic and social position of the
working classes. In specific terms, the main objectives of wage policy are as follows:
(i) To distribute the national product equitably by enlarging the incomes of the poorer sections of
the people and avoiding the concentration of wealth in the hands of a few rich.
(ii) To regulate the growth of the disposable income aiming at a level and pattern or domestic
consumption so as to generate adequate saving for non-inflationary financing of required
investment.
(iii) To end exploitation and provide remuneration to capital and labour. In the interests of the
consumers and the primary producers excessive profits should be prevented by suitable measures
of taxation and otherwise, both will share the product of their common effort after making
provision for payment of fair wages to labour, a fair return on capital employed in industry and
reasonable reserves for the maintenance and expansion of the undertaking (Industrial Policy
Resolution, 1947).
(iv) To fix statutory minimum wages in selected industries and promote four wages agreements in
more organized industries (Industrial Policy Resolution, 1948)

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 (v) To ensure equal pay for equal work (Constitution of India).
(vi) To provide for reasonable wage differentials to reflect differences in education, skills, job
requirements.
(vii) To regulate wages and salaries to eliminate/reduce undue disparities
(viii) To link remuneration to productivity
(ix) To compensate for the rise in cost of living.
(x) To determine for wages over and above minimum wages with due regard to the productivity
of labour, the prevailing level of wages, the level of national income and distribution, the place
of industry in the economy of the country, the capacity to pay, the basic needs of labour (the
15th session of Indian Labour Conference held in 1957 suggested that minimum wages be
need-based)
(xi) To secure a living wage for workers (Article 43, which is a part of the Directive Principle of
State Policy of the Constitution).
Legal Framework
The tone and tenor of public policy on wages and salaries in post independent India have been set
out in Industrial Truce Resolution (1947), Industrial Policy Resolution (1948), Concurrent List of Seventh
Schedule to the Constitution of India, successive plan documents, ministerial speeches etc. A number of
Acts have been enacted since then. At present, around 154 labour laws are in operation to ensure the
welfare of workers. Some acts are having important bearing on compensation policies .
Industrial Truce Resolution, 1947
In 1947, a Tripartite Industrial Conference was convened by the Government of India to discuss
industrial unrest. This conference adopted a very impotent resolution known as Industrial Truce Resolution,
1947. It recommended the setting up of suitable machinery for study and determination of fair wages and
conditions of labour. The emphasis was:
P To fix statutory minimum wages in sweated industries; and
P To promote fair wage agreements in the more organized ones.
Indian Parliament in pursuance of the Industrial Truce Resolution, enacted Minimum Wages Act,
1948 and appointed a Fair Wages Committee 1948
The Fair Wage Committee
The Fair Wage Committee (constituted in 1948) consisting of representatives of the Government and
those of employers’ and workers’ organizations submitted its report in 1949. The report introduced three
wage concepts, namely, Minimum Wage, Fair Wage and Living Wage.
To effectuate the recommendations of the committee, the Fair Wages Bill was introduced in the
Constituent Assembly of India (Legislature). However, the bill lapsed after the dissolution of Assembly
and was not revived again. The Constitution of India, which was adopted in November 1949, stressed
a “living wage” to workers as one of the Directive Principles of State Policy.
Wage Concepts
The committee on Fair Wages (1948) coined three terms minimum wage, living wage, and fair wage.
The 15th session of the Indian Labour Conference (1957) coined another term “need-based minimum
wage”. These terms are defined as under:
Minimum Wage
A minimum wage may be defined as that wage which is sufficient to cover the bare physical needs
of a worker and his family. Many people consider that minimum wage should also provide for other
essential requirements such as a minimum of education, medical facilities and other amenities. Thus, a

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reasonable standard of living should be permitted to worker from the stand-point of his health, efficiency
and well- being. Statutory minimum wage is fixed from this point of view.
There is a distinction between a bare subsistence of minimum wage and a statutory minimum, wage.
The former is a wage which would be sufficient to cover the bare physical needs of a worker and his
family. This is a wage which has got to be paid to the worker irrespective of the capacity of the industry
to pay. If an industrial organization is unable to pay to its workers at least a bare minimum, it has no
right to exist.
Fair Wage
A fair wage is something more than the minimum wage providing mere necessities. While the lower
limit of the fair wage must obviously be the minimum wages, the upper limit is set by what may broadly
be called the capacity of the industry to pay. Fair wage compares reasonably with the average payment
for similar task in other trades or occupations requiring the same degree of ability. Between these two
limits (minimum and maximum), wages should depend on a consideration of the factors like:
(i) the productivity of labour;
(ii) the prevailing rates of wages in the same or similar occupations in ‘the
Same region or neighboring regions;
(iii) level of national income and its distribution; and
(iv) the place of the industry in the economy of the country.
Living Wage
Living wage has been defined differently by different people in different countries. The most popular
definition of the living wage is that of justice Higgins of Australian Commonwealth Court of Conciliation
in the Harvester case. He defined the living wage as one appropriate for “the normal needs of the average
employee, regarded as human being in a civilised community”
According to the Fair Wage Committee Report, “The living wage should enable the male earner to
provide for himself and his family not merely the bare essentials of food, clothing and shelter, but also
a measure of frugal comfort including education for children, protection against ill health, requirements
of essential social needs and a measure of insurance against the more important misfortunes including
old age.” Thus, practically, living wage is a wage which provides the workers with a standard of life
furnishing him the necessities of life plus certain amenities considered necessary for the well being of
the working determined in terms of the position of the worker in a particular society. The Fair wage
committee was of the opinion that minimum wages must be given to the workers and living wages should
be the target.
In short, living wage is the target in all developing countries. Fair wage is a step toward living wage.
It is definitely more than the minimum wages, but is usually lower than the living wage. Fair wage
fluctuates between (i) lower limit set by minimum wage, and (ii) higher limit determined by firm’s
capacity to pay.
According to the fair Wage Committee, the goal of living wage should be achieved in three stages.
In the first stage, the payment of wage to the entire working class should be established and stabilized.
In the second stage, fair wages should be established in the community and industry. In the third stage
the working class should be paid the living wage. The living wage may be somewhere between the lowest
level of the minimum wage and the highest limit of the living wage, depending upon the bargaining
power of the labour, the capacity of the industry to pay, the level of national income, the general effect
of the wage rise in the neighboring industries, the productivity of the labour, the place of industry in the
economy of the country; and the prevailing rate of wages in the same or similar occupations in the
neighboring localities.
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Need –Based Minimum Wage (Indian Labour Conference, 1957)
The Indian Labour Conference in its 15th session held in July, 1957, suggested that the minimum
wage fixation should be ‘need based’ and should ensure the satisfaction of minimum needs of the
industrial worker. For calculation the minimum wage, the conference accepted the following norms and
recommended that they should guide all wage fixing authorities, including minimum wage committee,
wage boards and adjudicators, etc., of need-based minimum wage . The important points of the Resolution
of the conference are as under:
(i) In calculating the minimum wage, the standard working class family should be taken to consist
of three consumption units for the one earner, and the earnings of women, children and adolescent
should be disregarded.
(ii) Minimum food requirements should be calculated on the basis of a net intake of 2,700 calories,
as recommended by Dr. Aykroyed for an average Indian adult of moderate activity.
(iii) The annual requirement of cloth per member should be taken as 18 yards. That means a family
of four members require 72 yards of cloth.
(iv) The workers should get minimum rent as per guidelines fixed by the Government in industrial
housing policy.
(v) The provision for expenditure on fuel, light, etc, should be 20% of the minimum wages.
The minimum wages Act, 1948 did not define the Minimum Wage. Courts and employers go by the
definition given by the Committee on Fair Wages while trade unions would like to consider the need
based minimum wage concepts.
The first two Pay Commissions appointed by the Government of India did not accept the need-based
minimum wage formula because of budgetary implications, unemployment and low wage levels in
agriculture etc. The third and the Fourth Pay Commissions conceded, directly or otherwise, that except
in large organized private and public sector enterprises the actual wage levels fall short of the need based
minimum wage as per the formula recommended by the 15th Indian Labour Conference.
Other Wage Concepts
Nominal/ Money Wage: The earnings in cash or its equivalence.
Real Wage: Money Wages discounted by the cost of living index to denote the purchasing power of the
ways.
National Minimum Wages: National Minimum Wage means a uniform minimum wage for the country
as a whole. From time to time there have been demands particularly from trade unions, for a national
wage policy. The National Commission on Labour (1969) and the Study Group on Wages, Income and
Prices (1978) considered among other things, the question of a national minimum wage. The former
found it neither feasible nor desirable while the latter recommended but it was not endorsed by the
Government. It is generally recognized that fixation of minimum wage by the state may be impracticable
and also not in the interests o the workers.
The Factories Act, 1948
The Act applies to all persons employed in factories wherein 10 or more persons with aid of power
and 20 or more persons without the aid of power are or were, employed even for a day. It aims at securing
to workers health, safety, welfare, proper working hours and other benefits. It provides that the “occupier”
(the person who has ultimate control over the affairs of factory) should ensure a number of facilities and
conveniences like adequate information about the safe use of materials to workers; cleanliness of factory,
proper disposal of wastes and effluents, adequate ventilation, a reasonable temperature, dust and fumes
to remain within controllable limits, adequate facilities for washing, canteen (if 250 or more workers are
employed) and many more.

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 Talking specifically of overtime wages, as it is an issue relating to compensation, it provides for
payment of overtime wages at double the normal rate if a worker works beyond nine hours a day or 48
hours a week. However, no overtime is payable if worker is on tour.Total overtime hours in a quarter
should not exceed 50.
A worker is entitled in every calender year annual leave with wages at the rate of one day for every
twenty days of work performed in the previous calender year provided he had worked for 240 days or
more in the previous calender year. Application for leave should not normally be refused.
A child below the age of 14 cannot be employed.
The Factories Act provides for payment of various benefits by employers to their employees listed
below:
(i) Washing facilities for clothes and employees.
(ii) First Aid Appliances duly manned by qualified personnel.
(iii) Canteens of more than 250 workers are employed, to operate on no profit no loss basis by a
committee having representatives of management and workers.
(iv) Shelters, rest rooms, and lunch rooms if there are more than 150 workers.
(v) Creche where more than 30 women are employed for their children under the age of six years
(vi) Welfare officer, wherever more than 500 workers are employed.
(vii) Sitting facilities for occasional rest for workers who are obliged to work in a standing position.
The mines Act 1952, Plantation Labour Act 1951, The Contract Labour (Regulation and Abolition
Act) 1970, and Motor Transport Workers Act, 1961 are some other regulations for the welfare of employees
working in establishments other than factories, almost on the same lines as the Factories Act does, but
with some differences.
The Minimum Wages Act, 1948
The above Act requires the Central and State Government to fix minimum rates of wages in certain
scheduled employments.Employemtns specified in Part I and Part II of the Schedules appended to the
Act. The examples of such employments are woolen, carpet-making, rice, dal mills, tobacco industry,
plantations, oil mills, construction work, stone crushing, lac manufacturing, mica works, public motor
transport, and leather manufacturing and agriculture.
The act seeks to prevent exploitation of labour. The State governments are empowered to add to the
schedule, new industries. The Act also empowers the appropriate/government to appoint committees and
sub- committees to advise on fixation and revision of minimum wage rates. These committees consist of
representatives from employers, unions and governments.
An Advisory Board has been established for the purpose of co- coordinating the works of committees
The act covers all employees who are engaged to do any work, whether skilled, manual or clerical, in
any scheduled employment including any worker to whom articles or materials are given out by another
person for manufacturing or processing in his own house or elsewhere.
The Act does not, in itself, define minimum wages. The definition given by the Fair Wages Committee
is considered for legal interpretation. The minimum wages can be fixed by hour, day, month or such other
period. Rates can be prescribed for employment in different classes/categories of trades.
The Act symbolize the fulfillment of 1928 ILO convention on the subject.
Courts held that minimum wages be paid irrespective of the employer’s capacity to pay.
There is widespread criticism about several inadequacies in the implementation of the legislation. On
the one hand, prescribed minimum wages are low that they do not enable a person to come up the official
poverty level.
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 On the other hand, the employer feel that wage rates so fixed do not keep under consideration the
forces of demand and supply.
The Equal Remuneration Act, 1976
It provides for the payment of equal remuneration to men and women workers for some work of a
similar nature. It is in line with the provisions of Article 39 of constitution which emphasize on equal
pay for equal work. However, a recent study shows that women are still paid lesser than men (Times of
India, 22-5-06) even after so many years of its enactment.
At the end of the Minimum Wages Act, a study conducted by D.V.Giri and B.P.Rath on the
implementation of the Act in Orissa found (a) political factors play a crucial role in fixing précising the
minimum rates of wages; (b) minimum wage paid to the workers do not guarantee them minimum level
of sustenance; (c) the quality of inspection of adherence is very low; (d) the actual number of violation
could always be more than the reported number.
The Employees’ Insurance (ESI) Act State, 1948
The object of the Act is to provide certain benefits to employees in case of sickness, maternity,
employment injury, and certain other matters in relation thereto. Employees State Insurance Corporation
(ESIC) has been formed to supervise the scheme under Section 3 of the Act. As per Section 39, both the
employer and the employee have to make contribution to ESIC. The employer has to deduct contribution
from wages of employee and pay to ESIC the contribution of the both.
Their contribution is payable for wage period ‘which is normally a month. The employee’s contribution
is 1.75% of wages rounded off to next 5 paisa. Employer’s contribution is 4.75% of total wage bill (no
necessity of calculating each employee separately) rounded off to next to next 5 paise.
Section 73 of the Act provides that no employer shall dismiss or otherwise punish an employee while
he is on leave on medical grounds.
It extends to the whole of India. It applies to all factories. The Appropriate Government (State
Government with the approval of Central Government) can also make it applicable to any other
establishments, by issuing notification and giving six months notice.
An employee is entitled to get benefits which are medical benefits, sickness benefits, disablement
benefits as well as cash benefits. A person who has completed at least five years in employment is entitled
to get medical benefits for himself and his spouse, after superannuation. He has to pay a nominal amount
of Rs.120 per year.
The various benefits provided by the ESI Corporation are as under:
a) Medical benefits: The medical benefit to employee and his family can be of three types:
l Restricted medical benefit in the form of outpatient medical care at dispensaries or panel
clinics.
l Expanded medical care in the form of consultation with specialists, supply of special
medicine, X-ray and laboratory tests and calling a doctor to the worker’s residence to
see a serious case.
l Full Medical care. Hospitalization, specialist advice and drugs and diet are available for
in patient.
(b) Sickness Benefit: It involves costs payment for maximum period of 91 days for year to the sick
worker. The daily rate of sickness benefit is calculated at half of average daily wages. Workers
suffering from long-term disease like T.B ., Leprosy etc. are entitled to extended sickness
benefit as 62.5% of average wage for a period of 309 days.
(c) Maternity Benefits: An insured woman is entitled to receive cash benefit for confinement,
miscarriage or sickness arising out of pregnancy. The benefit is payable at double the sickness
benefit rate for a period of 12 weeks of which not more the 6 weeks shall precede the expected

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 date of confinement. If the insured woman dies during the period of confinement, her nominee
will receive the benefit for entire period.
(d) Disablement Benefit: Disablement Benefit for any injury arising out of and in the course of
employment which lasts not less than three days excluding the day of accident. In case of
temporary disablement, full pay is paid in addition to free medical treatment
(e) Dependent benefit : Dependent benefit in the form of pension is available to the widow of
worker, who dies as a result of industrial accident, throughout her life or till remarriage; the
sons get it till the age of 18 years; and daughters till the age of 18 or marriage whichever is
earlier.
(f) Funeral Benefit: The eldest surviving member of the deceased worker’s family is entitled this
benefit subject to maximum of Rs. 1500. It should be claimed within three months of the death.
An insured person who is entitled to any of these benefits shall not be entitled to receive any similar
benefit under and other law. Further an insured person shall not be entitled to receive for the same period:
(a) both sickness benefit and maternity benefit;
(b) both sickness benefit and temporary disablement benefit.
(c) Both maternity benefit and temporary disablement benefit.
Where a person is entitled to more than one of the benefits, he shall have to choose which one he
wants to avail..
The payment of Bonus Act, 1965
The payment of Bonus Act applies to every factory and every other establishment in which twenty
or more persons are employed on any day during an accounting year . The main purpose of the act is
to provide for the payment of bonus to persons employed in certain establishments and for matters
connected therewith. It provides for a minimum (8.33% of pay) and maximum (20% of pay) bonus and
for negotiations on bonus. The minimum bonus is payable, subject to certain exemptions specified in the
Act, irrespective of profit/loss. The act is supposed to reduce industrial conflicts on account of bonus .
Bonus is payable annually within 8 months from close of accounting year.
It is payable to all employees whose salary or wages do not exceed Rs. 3,500 per month provided
they have worked for at least 30 days in the accounting year.
Once the Act is applicable, it continues to apply even if number of employee’s falls below 20.
The Act is applicable to Government companies, the employees of Municipal Corporations, railways,
University ,RBI, public sector financial institutions. It does not apply to any institution established not
for purposes of profit.
Maternity Benefit Act, 1961
Maternity benefit is “an indemnity for the loss of wages incurred by a woman who voluntarily before
children and compulsorily thereafter abstains from work in the interest of the health of her child and
herself.” The main purpose of the Act is as under:
a) To regulate the employment of women employees in certain establishments for certain specified
periods before and after childbirth.
b) To provide for the payment of maternity benefits to women workers at the rate of average daily
wages calculated on the basis of wages payable to her for the days on which she has worked
during the three calendar months immediately preceding the date from which she absented
herself on account of maternity.
c) To provide for certain benefits in case of miscarriage ,premature birth,or illness arising out of
pregnancy.

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 The Act applies to factory, plantation and mines not covered under ESI Act, 1948. Women employee
who has worked in for minimum of 80 days is entitled to claim maternity benefit for a maximum of 12
weeks, including pre- and post- natal periods.
Wage Policy Under The Five Year Plans
The five year plans explicitly dealt with industrial wage policy an important factor promoting industrial
development through worker satisfaction and ensuring industrial peace and social justice.
The First Five Year Plan (1951 to 1956) cautioned against a general upward movement of wages to
check a wage price spiral. It recommended that wages should be increased to remove anomalies or where
the existing rates were very low. It further suggested various measures for making wage adjustments like
reduction of disparity in income, reduction of gap between the existing and living wages.
The Second Plan (1956 to 1961) suggested a wider application of the system of payment by results with
due safeguards such as protection against fatigue and under speed up. The plan recommended settlement
of industry wise wage disputes through tripartite wage boards. The controversial need based pay concept
was recommended during this plan by the 15th Indian Labour Conference .Another major development
was the report of the second pay commission for Central Government Employees.
The Third Plan (1961 to 1966) and the fourth plan (1969 to 1974) did not introduce any thing new
to the government’s wage policy. The third Pay Commission’s report came in 1973.
The fifth Plan suggested the built up of a national wage structure over a period of time. A committee
on wage policy was established which released its report at the end of 1975. The report relates to the
problems of wage policy in the organized sector of the economy excluding the Government sector. The
committee felt that the objectives of wage policy cannot be accomplished if wage fixation is left to the
forces in the labour market. The committee suggested that the objectives of the wage policy should
include provision of minimum wages, distribution of due share to every stakeholder, rationalization and
minimization of wage differentials, removal of malpractices in the payment of wages etc. The committee
assisted that salaries in the private sector should be consistent with those in public sector. It suggested
the establishment of a National Wage Board to implement the policy.
The other five year plans, sixth, seventh, eights, ninth and tenth have been discussed later in this
lesson.
Study Group On Wages, Incomes, Prices
(Bhootlingam Committee)
In October 1977, a six member study group on Incomes, Wages and Prices was set up with S.
Bhootlingam as its head, by the Ministry of Finance, the Government of India. The group reported its
findings in six months and made 93 recommendations. Some of them are as under:
P It considered bonus as related to profits and suggested a gradual transformation of the bonus
system into a social security scheme like pension covering all wage and salary earners, setting
up of a pension bureau.
P Uniform rate of Dearness Allowance irrespective of salary drawn.
P Removal of disparities in salary structure between the Central and the State Governments and
among State Governments.
P A national minimum wage of Rs 100 per month at current prices of Rs. 4 per day for eight
hours work.
P The appointment of national pay commission in consultation with the states to consider the
question of upward revision of salaries at upper level of management hierarchy in Government
and public sector undertakings.
ü The appointment of a pay committee to go into emoluments and service conditions of Government
and industrial employers after comparing with corresponding employees in private sector.

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 P A non- statutory body to be known as “Bureau of Incomes and Price” to undertake continuous
review of relevant data and to determine each year the guidelines for the industry and group
of industries, and settlement of wage disputes.
P Wage disparities between the lowest and the higher wages in a unit should be narrowed to four
to five times.
ü Consumption expenditure should be restrained up to a certain point, although not specified,
beyond that there should be compulsory savings.
P Wage revision in future should be linked to increase in productivity since it has a system of
compensating for increase in the cost of living.
P Dearness allowance should be linked to the cost of living at the rate of Rs. 130 per point on
the basis of an all India average consumer price index.
P It recommended the stabilization of the cost of living though that did not mean wage freeze.
P Disparities in the salaries of public and private sectors should be narrowed, for the next five
years for new contracts in the private sector; the limit should be fixed at Rs. 6,000 p.m.
P Dividend should be restricted to a rate 2 to 3 percent lower than the rate of earning considered
as necessary to attract enough investment to accomplish the growth of the industry.
The Bhootlingam report has been severly criticized by both employees and the employers. Some criticisms
are as under:
Ø The recommended minimum wage is too low and does not meet the long standing demand
of trade unions to increase it to Rs. 300
Ø Committee has not accepted the concept of bonus as “deferred wage” which the Government
has already accepted.
Ø Regarding pay disparity between the government and the private sectors, the Government does
not get even 1/3 of his counterpart in private sector although with similar management functions.
Ø The disparity between the proposed national minimum wage and maximum income group be
narrowed only if maximum salary and income limits are prescribed.
Still, the committee’s report forms a significant approach to solve the chronic problems of Indian
economy. It has been appreciated on the following grounds:
Ø Establishment of link between wages and productivity.
Ø Ensuring the workers a fair share in the benefit of growth.
Ø Non-imposition of wage freeze.
Ø Suggestion of point formula for calculation dearness allowance as it will ensure fairness in
calculation to all irrespective of the level of income.

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 LESSON 10

WAGE BOARD ANY PAY COMMISSION

Dr. Neetu Jain
ADIAS
Institute of Management
This is one of the important institutions set up by the Govt. of India for fixation and revision of
wages. Separate wage boards are set up for separate industries. Govt. of India started instituting Wage
Boards in accordance with the recommendations of Second Five year Plan, which were reiterated by the
Third five year plan. Wage Boards are not governed by any legislation but are appointed on ad-hock basis
by the Govt.
Each Wage Board consists of one neutral chairman, two independent members and two or three
representatives of workers and mgt. Each. The Wage Boards have to study the various factors before
making its recommendations. The recommendations of the wage board are first referred to the Govt. for
its acceptance. The Govt. may accept with or without modifications or reject the recommendations of the
Wage Board. The recommendations accepted by the Govt. are enforceable by the parties concerned.
The Wage Boards take the following factors into consideration for fixing or revising the wages in
various industries:
1. Job Evaluation
2. Wage rates for similar jobs in comparable industries
3. Employees productivity
4. Firms ability to pay
5. Various wage legislations
6. Existing level of wage differentials and their desirability
7. Government’s objectives regarding social justice, social equality, economic justice and economic
equality
8. Place of industry in the economy and society of the country and the region
9. Need for incentives, improvement in productivity etc.
The Wage Boards fix and revise various components of wages like basic pay, dearness allowance,
incentive earnings, overtime pay, house rent allowance and all other allowances.
Growth and Development of Wage Boards
Wage boards are also known as Trade boards, Wage councils, Wage committee, Wage commission
etc. The history of Wage boards in India dates back to the 1930’s. The royal commission on labor
recommended the setting up of tripartite boards in Indian industries. But the recommendations were not
accepted by the then govt. After independence, the Industrial Dispute act was enacted under which
disputes regarding wages could be settled through adjudication.
Compositition And Function Of Wage Boards
1. Composition of Wage Boards
It is a tripartite body representing the interests of labor, management and the public.The labor and
mgmt representatives are nominated in equal numbers by the govt.after consultation with the major
central organization. Generally the labor and management representatives are selected from the particular
industry which is investigated. The board is chaired by a judge. The boards are generally of two types
1. Statutory
2. Non statutory : They are set up by a central resolution of the central govt. and come to an end
with the submission of the report.
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2. Functions of Wage Boards
The wage boards are required to:
1. Determine which categories of employees (manual, clerical, supervisory) are to be brought within
the scope of wage fixation
2. Work out a wage structure based on the principles of fair wages formulated by the committee on
fair wages
3. Suggest a system of payment by results
4. Work out the principles that should govern bonus to workers in industries
Though W.B deal with a large no. of issues but fixation of wage scales on an industry basis
constitutes the biggest of all the issues before them.
Working of the Wage Boards
Although the wage boards are set up by the govt., the basic reason for their establishment is the
pressure brought to bear on the govt. by the trade unions, industrial federations and national organizations.
The Functioning of Board Involves three Steps
1. The first step is to prepare a comprehensive questionnaire designed to collect information on
the prevailing wage rates and skill differentials, means of assessing an industry’s paying capacity,
most desirable methods measuring worker capacity and workloads, prospects of industry in
immediate future and regional variations in the prices of widely consumed goods. The
questionnaire is sent out to labor unions, employers’ associations, academic organization and
govt. agencies.
2. The second step is to give a public hearing at which the labor leaders and employers’ associations
, not represented on the board, as well as others interested in the industry in question, are given
a verbal hearing on issues dealing with wages, working conditions and other items.
3. The third step is to convene secret sessions at which members of the board make proposals and
counter proposals regarding the items to be covered.
Finally the decision of the board is written down (unanimous) and submitted to the govt. After
receiving the report, the govt. examines it and modifies it if found necessary.
Wage Boards—The Indian Scene
The first non statutory wage board was set up for the cotton textile and sugar industries in 1957.
Since then, till 1994, as many as 28 wage boards covering most of the major industries have been set
up by the center
Viewpoint of National Labour Law Association on Wage Boards
The commission observed that the sprit of cooperation among parties has evaporated and each party
has started mistrusting the other. Accordingly, there was inordinate delay in completing the work and
even when completed; the recommendations came to be challenged in the courts stalling their
implementation. The practice of setting wage boards has, therefore, gradually been discontinued. In order
to minimize litigation on the awards of Wage Boards, the Association proposed to make them final and
binding subject only to an appeal to National Labour Relations Commission. It is also proposed to keep
the awards in operation for a minimum of three years which may be extended by mutual agreement
between the parties. It is also suggested that there should be an enabling provision in the law for setting
up wage boards for any activity when necessary in consultation with the most representative organizations
of employees and employers concerned.
The Sixth Plan (1980 to 1985)
The sixth plan (1980 to 1985) pointed out significant wage disparities between organized and
unorganized sector and urban- rural sector. It further observed that wage level in the organized sector

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varied not only between regions and industries but even among units in the same industry. These levels
were related neither to the nature of occupations nor to the level of skills. The anomalies and disparities
have resulted in social tensions and industrial unrest. Therefore, the plan stressed the need for:
a) rationalization of wage structure;
b) linking of wages to productivity;
c) generating a climate conducive to modernization in industry and adoption of new techniques
which help in increased productivity, without being detrimental to employment.
The Seventh Plan (1985 to 1990)
The Seventh Plan (1985 to 1990) visualized a rise in the levels of real income in consonance with
increases in productivity, sectoral shifts in the desired direction, and reduction in disparities. The plan
suggests that wage employment and the scope for its further increases could be relatively limited.
A major event during this plan period was the report of the Fourth Central Pay Commission which was
submitted in June 1986.
The Eighth Plan (1992 to 1997)
The Eighth Plan (1992 to 1997) makes significant departure from the proceeding wage policy. It
focused on National Policy on Child Labour (1987), bonded labour, rural labour, contract labour, women
labour and interstate migrant labour. The major departure has been in the form of a new wage policy for
public enterprises. (Described later).
The Ninth Plan (1997 to 2002)
The Ninth Plan (1997 to 2002) suggested many steps for the improvement of the condition of labour.
Some selected steps are: While reviewing Labour Laws, the report states that benefits from existing
labour laws reach a minor part of the workforce because of administrative difficulty in implementation.
Ninth plan aimed at reducing the number of laws with the objective that a much smaller number can reach
the entire workforce. The Ministry of labour has taken the preparatory steps in this direction.
In the light of changed conditions governing employment and industrial relation due to economics
reforms, National Renewal Fund has been created out of which payments are made to the workers who
are voluntarily retiring and funds are also provided for retaining and redeployment of retrenched workers.
Steps need to be taken so that less out of reform process is minimum for the labourers.
In the 33rd session of the Standing Labour Committee, was felt that measures should be taken to
evolve a uniform flour level minimum wage for all unorganized establishments. The need for so fixing
and notifying minimum wages that no wage is fixed below Rs. 35 per day was felt. It was also suggested
to the governments that the existing benefits should not be reduced and wherever the current level of
minimum wages are more than Rs. 35, they should be allowed to continue. The state Governments were
also requested to take measures to reduce interstate and intera state disparity in minimum wages.
The Minimum Wages Act 1948, is primarily applicable to unorganized sector/sweated sector. It
includes urban informal sector, agricultural labour, migrant labour, women and child labour, and poor
workers.
The Plan intends to expend the applicability of the Employees State Insurance Scheme (ESI) by
making it applicable to all factories employing 5 or more persons.
The Tenth Plan
It emphasized a review of the structure of labour laws in the perspective of the structure of the labour
market in the following words: Labour laws are relevant for the wage employed, and not the self-
employed. Out of the total estimated number of workers, 47. 1 per cent are wage employed. Among these,
25.3 per cent are in the agriculture sector where labour laws do not generally apply; 11.7 per cent are
in the services sector and 10.2 per cent in manufacturing, mining etc. A good part of services is the
employment in Government establishments where the industrial labour laws do not apply. Among the

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wage employed, the labour laws apply to these hired on a regular salaried basis. Only about one third
of the wage employed are hired on a regular salaried basis. Thus the present structure of the labour
market is such that the labour laws apply to a small part of the labour force. Hence, any immediate impact
of changes in labour laws will be rather small.
In the light of the Report of Second National Commission on Labour, restructuring of labour laws
is being examined by the Government. Some such laws are Industrial Disputes Act 1947,The Contract
labor Act,1947, the minimum Wages Act, 1947.Certain provisions of the Companies Act, 1956 relating
to stock options etc., have been modified considering the market sentiments and recent developments in
the United States. They have been incorporated under Companies (Amendment) Act, 2001.
Implementation
The work of reforming the laws has already begun. The Payment of Wages (Amendment) Act, 2005,
proposing to enhance the wage ceiling from the present level of Rs. 1,600 per month to Rs. 6,500 per
month and empowering the Central Government to further increase the ceiling in future by way of
notification, has already been but into effect from November 2005. Other reforms under active consideration
are:
(a) the Factories (Amendment) Bill 2005 proposing to provide flexibility and safety to the employed
women;
(b) amendment of Labour Laws (Exemption from Furnishing Returns and Maintaining Registers by
Certain Establishments) Act, 1988.
Pay Commissions
This is another institution which fixes and revises wages and allowances of the employees working
in govt. and central and state governments. Central governments so far has appointed six pay commissions.
The First Pay Commission
This commission was appointed by the central govt. in the year 1946 with Varadachariar as Chairman.
This commission stated that the state must now take some steps to implement the living wage principle.
The commissioner recommended the min. wage at Rs. 30 for the lowest grade of class VI employees in
the central govt. The commission felt that the hardships of the lowest paid employees should be relieved.
The Second Commission
The central govt. appointed the second pay commission in August 1957 with a view to recommending
revised pay scales for different classes of employees of central govt. It submitted its report in Aug.
1959.This commission visualized dearness allowance as a device to protect to a greater or lesser extent,
the real income of wage earners and salaried employees from the effects of rise in prices.It also
recommended that the min. wage should be fixed at Rs. 80 per moth.
The Third Pay Commission
Due to continuous demand by the employees of central govt. and their organizations, the govt.
appointed Third pay commission in April 1970 .It submitted its report in 1973.It stressed on the reduction
of prevailing numerous pay scales by compiling the posts of several different categories and occupational
groups in one single grade. It was set up with a view to examine the principles which would give the
structure of remuneration and conditions of service of central govt. employees and to consider and
recommend the desirable feasible changes in the structure of remuneration and conditions of services of
central govt. employees.
The Fourth Pay Commission
The Fourth Central Pay Commission appointed under the chairmanship of justice, P.N. Singhal in
September, 1983 submitted its report in June 1986. It was specifically asked to:
P examine the variety of allowances and benefit in kind;
P Suggest their rationalization and simplification.
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 The commission gave its report in two parts:
P Part 1 relates to structure of emoluments, conditions of service to Central Government Employees
including union territories, members of all India services and personnel belonging to Armed
forces.
P Part II deals with the pension structure for pensioners including both past and future and the
death cum retirement benefits for all categories of employees.
The commission felt the rejection of parity in pay scales of central Government employees with those
of public sector undertakings unreasonable.
It also expressed the need to rationalize transfer/travelling allowance rules to resolve various problems
and hardships which the transferred employee is subjected to. The commission has been appreciated for
providing a new dearness allowance formula, liberalization of HRA and withdrawal of overtime allowance
for non-industrial employees.
The Fifth Pay Commission
The Fifth Pay Commission was formed in April 9, 1994 under the Chairmanship of S R Pandian, a
retired Supreme Court Judge. The other members were Suresh Tendulkar and M.K. Kaw. The Commission
gives its report in January 1997. It is in three volumes.
The commission’s report has caused immense contradictions and resentment. It made 99
recommendations. Some of them are:
(1) Increase of lower level employees by 20 to 40 per cent and that of senior level bureaucrats by
almost 130 percent.
(2) Reduction in hiring, abolishing currently vacant posts, and restructuring Government departments.
(3) Several recommendations to improve productivity:
Ø A six day week instead of five; the number of gazetted holidays be reduced from 17 to three
(Republic day, Independence Day. Mahatma Gandhi’s Birth Day); a holiday be declared only
on the death of an incumbent Prime Minister or President and on no other deaths.
Ø All payment of overtime allowance to employees should be discontinued; instead, staff deployed
on weekly off-days may be given compensatory leave.
Ø The introduction of a time-punching machine, to ensure punctuality in every office-applicable
even to the Cabinet Secretariat.
Ø Phasing out of staff cars by attaching such cars only to top executives; beginning common pool
of private vehicles; freezing the cadre of staff car drivers; and abolishing vacant posts of
drivers.
Ø Increase timings of government-run service institutions like banks, hospitals, dispensaries and
shopping centers by introducing a shift system in these places.
l Maternity leave be increased to 135 days to all married/unmarried Central
Government’s woman employees provided the number of her surviving children
is less than two.
In case of miscarriage, the leave entitlement is for 45 days irrespective of the number of children.
Such leave granted is full pay and it may be combined with leave of any other kind.
l 15 days paternity leave is granted to all Government employees with less than two surviving
children. It can be combined with leave of any other kind except casual leave.
l All ad-hoc bonus schemes should be made productivity related and a performance related
increment scheme should be introduced.
l Till the finalization of the recommendation, the commission can also suggest an interim relief.

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The Sixth Pay Commission
The Central Government has set up the Sixth Pay Commission. It is mandated to look at the salary
structure for all central government employees. It is also to suggest ways to improve the functioning of
the government given the change in its role. It would also look at providing suitable incentives for
performance. Till the finalization of the recommendation, the commission can also suggest an interim
relief for the concerned employees.
Regulation of Managerial Remuneration
The regulation of managerial remuneration is a special feature of company law in India. Section 198
of the Companies Act provides for an overall ceiling of 11 per cent of the net profits as the maximum
managerial remuneration that can be paid by a public company in any financial year to its directors,
managing director(s) or manager and whole time directors. Within the above said maximum limits, a
company can pay monthly remuneration to its managing/and whole-time directors or the manager as per
Section 309 and 387 respectively. The percentage shall be exclusive of fees payable to the directors for
attending the board meetings. Subject to Section 269 and Schedule XIII of the Companies Act, if in any
financial year, the company either has no profits or not adequate profits, the company shall not pay any
managerial remuneration except with the approval of the Central Government. The Schedule XIII has
been amended from time to time. According to the latest amendment made w.e.f 16.01.02, different limits
and scales have been specified for the payment of remuneration to the managerial personnel where in any
financial year, the Company has no profit or if its profits are inadequate. When there is no profit or profits
are inadequate, there is no need to take Central Government’s approval for the payment of managerial
remuneration, if it is laid within such limits.
Several arguments have been made in support of the regulation of managerial remuneration. Some
of these include the following:
(1) The per capita income is low and a large proportion of India’s population has remained poor
over time.
(2) High salaries encourage conspicuous consumption which have undesirable socio-economic
effects.
(3) The public policy seeks to reduce income disparities.
(4) Safeguards the interests of public, consumers, including minority shareholder.
(5) Avoid unfair competition in managerial remuneration to attract talent which may have undesirable
impact on the social welfare sectors of the economy.

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