Items Description of Module

Subject Name Human Resource Management

Paper Name Performance and Compensation Management
Module Title Factors influencing Compensation Management
Module Id Module No. – 23
Pre- Requisites Basic understanding of Compensation management
Objectives To develop effective understanding about the factors affecting compensation
management
Keywords Compensation management, Internal factors, External factors
QUADRANT-I

1. Module 23: Factors influencing compensation management

2. Learning Outcomes
3. Introduction
4. Process of performance reward
5. Factors influencing compensation management
6. Summary

1. Module 23: Factors influencing Compensation Management

2. Learning Outcomes:
By the end of this module, students will be able to
 Understand the concept of compensation management
 Identify determinants of compensation
 Know about different wage determinants models

3. Introduction
The aggregate macroeconomic conditions of the country play a significant role in determing the
compensation paid. For e.g. If an economy is on the high growth trajectory, the employees will
receive hgh compensation. Conversely if the economy is recessing, the employers will have the
tendency to pay low or cut salary likes and so on. Similarly the demand for particular skill set will
impact compensation heavily. Then the positioning of the specific firm in the business cycle and also
the level of vacancy and urgency of it being filled affects the compensation. The negotiation with the
employer, the appraisal system, the culture within the organization, the level of communication
amongst the employee and many more such factors affect the compensation paid to employees.
Compensation is the reward given to employees in return of the work done by them for the
organization. The work done & the compensation paid both are dependent on several factors.
The compensation to be paid to employees is significantly influenced by the economic-social-
political-cultural environment of the country. The stage of development (developed-developing-
underdeveloped) is another factor that decides the compensation. This indirectly states the availability
of desired levels of skills for the particular job and this again influences compensation. These are
 some external impacts. Similarly there are some internal aspects of the organization that influence the
compensation.
4. Process of Performance Reward
Employee’s compensation is dependent on a variety of factors like type of job, desirable skills,
working conditions, scale of operation, ideology/philosophy of the organization, trade unions,
competitive environment, political and social scenario etc. Keeping in mind the global scenario in
various sectors (including the knowledge intensive sectors) employees are often treated as value
creators for the organization. So it is important for organizations to have Compensation that can
appeal and retain the best of talents. Therefore Compensation is a very critical aspect of any
organization from the point of view employer, employee as well as nation building. Performance
reward is one of the important methods to motivate employees to work at their best efforts. Different
organizations use different methods of rewarding employees. Different steps involved in a good
reward system are described below:
a) Establishment of performance standards: The reward process in any organization starts with
the establishment of criteria to be used for appraising the performance of employees. The criteria
can be specified with the help of job analysis and job description which indicates the contents of
the job. For the success of performance reward system, the criterion must be objective, clear and
in writing. It must be discussed with supervisors so as to ensure that all the important factors have
been included and nothing relevant has been missed out. If the output can be measured easily then
the criteria is clear. But if the performance cannot be measured easily, the personal characteristics
which contribute to employee performance should be determined. Some of the examples of these
characteristics include quality of work, leadership, cooperation and team work, learning ability,
health and physical condition, etc. These standards must be written on the reward form. Who
shall be appointed as appraiser and how frequently reward is to be done must be decided in
advance so as to avoid future conflicts in the organization.
b) Communication of standards to all employees: The performance standards set in first step
should be communicated to the employees properly so that they are aware of what is expected of
them. Employees must be asked whether they agree or not with the standards and necessary
changes must be made according to the suggestions made by the employees.
c) Measurement of performance: After setting up the performance standards, actual performance
of the employees is measured. For this purpose the best technique of correctly measuring the
performance has to be chosen, internal and external factors affecting the performance must be
identified and information on the results achieved is to be collected. All this information can be
obtained from written reports, face-to-face contact, personal observation, etc. The performance of
 employees should be measured in such a way that it is easy to compare the performance of one
employee with the other.
d) Comparison of actual performance with standards: After this the actual performance is
compared with the predetermined performance standards. This comparison might disclose some
differences. These differences can be positive or negative. Positive differences occur when the
actual performance is better than the standards whereas, negative deviation reflects that the actual
performance is poor than the standards.
e) Discussion of reward with employees: The results of the Reward are then discussed with the
employees along with the reasons behind them. Such discussion helps employees to identify their
strengths and weaknesses so that they can be motivated to improve their performance.
f) Taking corrective action: After discussing with the employees, all the necessary steps which are
required to improve the performance of the employees are identified and initiated. Performance
can be improved with the help of training, coaching, counseling, etc.
5. Factors Affecting Compensation Management
factors affecting compensation management may be like organization philosophy, ability to pay, job
specifications, etc. For the purpose of study we will divide the factors affecting compensation into
two categories:
1) External Factors
2) Internal factors

FACTORS INFLUENCING COMPENSATION MANAGEMENT

EXTERNAL FACTORS INTERNAL FACTORS

1. Market forces 1. Nature of job

2. Trade Unions 2. Ability to pay
3. Social Structure 3. Organizational strategy
4. Inflation 4. Employee characteristics
5. Technological and qualities
changes
5.1. External Factors:-

Every organization has to function in environment that is created by the macro-economic factors
prevailing globally. As, these factors cannot be directly controlled or influenced by the organization,
the organization has to accept those factors as it is and then formulate their own strategies, rules &
regulations accordingly. This applies to the management of compensation systems too.

1) Market Forces: - Market forces play a very important role in determination and functioning of
the compensation management system of an organization. Here specifically we will talk of the
human resource market. While studying the HR market we will analyze the two most important
constituents of HR market:-
A) Demand and supply
B) Prevalent wage rates
A) Demand for and supply of personnel functions technically as well as geographically. Firms
are bound to pay compensation as per requirements & availability of the particular skill set at the
particular point of time at the desired geographical location. Thus, if requirement of certain
category of personnel is higher in number as compared to the availability, the compensation tends
to be higher. Premium skills like consulting, accountancy, technology professionals and the kind
are always paid higher. The firms are then supposed to go beyond the prevailing compensation
plans in order to attract and maintain the top notch/ skilled employees. Such a strategy helps to
hold the ‘cream of the crop’ within the organization. Hence, it is the expertise & the relative
availability of such premium skills that determines how an employee has to be compensated.
B) Prevalent wage rates: - The rates that are prevalent in the market are another factor that
influences the compensation management of the organization. There are few points which need to
be considered here. Firstly, to invite individuals with a certain skill set, it is necessary to
compensate them at par with similar organizations.
 Minimum Wages Act, 1948:- The main objective of this Act is fixation of minimum rates of
wages in certain employments. It is applicable to industries in which more than 1000 people
are employed. This act provides for fixation of minimum time rate, piece rate, guaranteed
time rate and overtime rate. Every employer is required to pay his employees, wages at rate
not less than the minimum rate of wages without any unauthorized deductions.
 Equal Remuneration Act, 1976: - The main objective of this Act is to provide equal
remuneration to men and women for the same work and to prevent any discrimination on the
 basis of sex in the matter of employment. No employer shall discriminate against women
while making recruitment for the same or similar work. Any employer who does not follow
the rules framed under this Act shall be punished with a fine of Rs. 10,000.
 Payment of Wages Act, 1936:- This Act timely payment of wages and tends to avoid
unnecessary delay in payment of wages & prevents unauthorized deductions from wages. It
extends to whole of India. According to this Act, the wages of a person who is employed in
an organization in which less than 1000 people are employed, shall be paid before the expiry
of 7th day and in other cases wages should be paid before the expiry of 10th day, after the last
day of the wage-period in respect of which wages are payable.
 Payment of Bonus Act, 1965:- This Act provides for the payment of bonus to employees on
the basis of profits and productivity. This Act applies to every factory or establishment in
which 20 or more people are employed on any day during an accounting year. Bonus shall be
paid to a person if he/she has worked for at least 30 days in that year. The minimum rate of
bonus shall be 8.33% of the salary or wages earned by an employee in an year or Rs.100,
whichever is higher. An employee will be disqualified from receiving bonus if he/she is
dismissed from job for fraud, violent behavior on premises or theft, misappropriation of any
property of the organization.
 Payment of Gratuity Act, 1972:- This Act was enacted on august 21, 1972. It extends to the
whole of India. It is applicable to every factory, mine, oilfield plantation, port and railway
company, every shop or establishment in which 10 or more person are employed or were
employed on any day of the preceding 12 months. An employee shall be eligible to receive
gratuity only if he has continuously worked for at least 5 years in that organization. The
formula to calculate gratuity is:

15
𝐺𝑟𝑎𝑡𝑢𝑖𝑡𝑦 = 𝐿𝑎𝑠𝑡 𝐷𝑟𝑎𝑤𝑛 𝑠𝑎𝑙𝑎𝑟𝑦 × × 𝑁𝑜 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠 𝑜𝑓 𝑆𝑒𝑟𝑣𝑖𝑣𝑒
26

Gratuity shall be payable from the date it becomes payable. Gratuity received by
government employees is exempt from tax subject to a maximum of Rs.10,00,000 or 15
days salary of each completed year of service.

Secondly, to retain individuals i.e. to prevent employees from going to work with
competitors, the organization needs to pay competitively or may be even higher than
prevailing rates to retain them. Thirdly, the compensation management has to understand
& accept the labour union pressures and then decide its own systems.
2) Laws & Regulations: - They are very important influencing factor for compensation and its
management. In a country like India, there are numerous laws at the central as well as the state
level. Apart from the laws there is certain regulatory restriction that has to be taken care of by the
organizations. These regulations obviously vary across geographical locations. They may be
related to the average working hours, minimum wages, overtime wage rates, compulsory bonus
etc.
3) Trade Unions: - Trade unions are associations of workers formed with various interests and they
take care of remuneration & working conditions of the employees. These days trade unions are
very important in certain areas of operations and are in position of strongly influencing the
compensation plans of the organization. The influencing power of the trade union depends upon
the membership, its financial position, leadership, political backing and past records. Trade
unions may be of any of the following types:-
(i) Craft union represents a particular craft like weavers
(ii) General union represents any general group of employees
(iii) Industrial union represents a particular industry like textile
(iv) White collar union represents a particular profession like doctors engineer etc.

Various employee unions carry out a number of functions. Some of these are like negotiating on
behalf of members on working condition, working hours, remuneration etc. These unions protect
workers’ rights, help through training schemes & education. Sometimes these unions provide
financial help to its members in times of strikes, sickness casualty etc. at times they may also
pressurize the Govt. to pass certain laws in favour of the member workers.

4) Social Structure: - In some cases the compensation management system may be influenced by
social structure too. In each society some societal norms become significant like that of fair
wages, descent employment, respectable organization and compensation structure. The
organizations as well as the employees keep this in mind while offering and receiving
compensation. There may not be any legal binding to it, but it is accepted as a matter of socio-
ethical practice.
5) Inflation:-It affects the cost of living of the employees. This also varies internationally,
domestically (urban and rural), and sometimes also over different periods of time because of
inflation. This influential factor of compensation management can be taken care of by variation in
the basic structure of compensation like differences in dearness allowance, city compensation
allowance, etc. The main idea behind this variation in compensation is managing the varied
 inflation effects and maintaining parity among employees. In India in 2012, nearly 22 listed
companies had raised salary (12-27%) of their employees due to inflation.

Source: http://www.thebreakingtimes.com/inflation-nigeria-in-uncharted-territory/
6) Technological changes: - With rapid technological advancement & technology becoming
obsolete very fast, skilled manpower shortage poses serious problems sometimes. This forces
revision of compensation plans as a part of compensation management within the organization.
5.2. Internal Factors:-
Compensation management as a part of HRM system of the organization is internally affected by
numerous factors. That is why the compensation plan of each organization is different, in spite of
the businesses being the same. Some of the internal influences may be summed up under the
following heads:-
a) Nature of Job: - Compensation and its management are directly influenced by the nature of
the job. Compensation is higher for difficult jobs & for those where accountability is also
high. Although job evaluation gives details about the job profile & risks associated with it,
but in some cases this may not project the real nature or worth. So compensation management
system has to meticulously study and plan its process according to the nature of the job.

Source:https://www.shutterstock.com/image-vector/good-work-salary-vector-flat-illustration-
348002330?src=VK3LRIlRNa6mYYRB2IabXA-1-67
 b) Ability to pay: - Financial position of the organization and competition faced are two major
factors that affect the paying capacity of the organization. In private sector the compensation
are directly related to profit earning that depends on productivity of employees. So in a way
compensation paid by organization is related to the productivity of employees. The wage and
salary disposition depends on the ability of the organization to pay. These days it is very
common that the payment to employees comprises of the portion that is variable i.e. some
part of the compensation that an employee receives fluctuates according to the variations in
the earnings of the organization. So with the variation in ability to pay, the compensation
management system has to modify its procedures too.
c) Organizational strategy: - The compensating strategy of two organizations even functioning
under same economy may vary. That is to say that compensation strategy of two
organizations is always different. One may want to be an industry
leader in terms of compensation payment, while another may
want to be wage competive. The compensation management
system is completely linked to the organizational strategy i.e.
compensation plan is completely influenced by the strategy, a
rapidly growing organization, keeping the market HR trends in
mind, has to manage its compensation plans such that retaining
employees becomes easy because training of new staff would
waste a lot of otherwise productive time of trainer and trainee as
well.

Source: http://www.referenceforbusiness.com/photos/strategy-implementation-4.jpg
d) Employee characteristics and qualifications: - Skill sets of employees influence the
compensation management system effectively. These could be related to experience,
seniority, performance, potential for improvement etc. If an employee is highly qualified and
possess relevant experience along with the qualification then definitely the compensation paid
to him/her may be beyond normal. Also, sometimes an employee may not possess any
specific educational qualification but he/she may be an expert in a particular field of work.
Here again the compensation paid would be extra ordinary.
Source: https://bethkerrblog.files.wordpress.com/2011/09/istock_000014181803xsmall1.jpg

6. Summary: -

The study of various factors affecting compensation reveals that a combination of numerous factors
directly or indirectly affects the rates at which employees are compensated. The compensation paid to an
individual depends a lot on one’s qualifications and skills. But it is also influenced by various external &
internal factors. External factors are beyond the control of the organization while internal factors are those
that are very organization specific and vary largely from one organization to another. Any organization
has to function in environment that is created by the macro-economic factors prevailing globally. As,
these factors cannot be directly controlled or influenced by the organization, the organization has to
accept those factors as it is and then formulate their own strategies, rules & regulations accordingly.
Compensation management as a part of HRM system of the organization is internally affected by
numerous factors. That is why the compensation plan of each organization is different, in spite of the
businesses being the same.