Everything you need to know about compensation management. Compensation or reward management is concerned with the formulation and implementation of strategies and policies which are to reward people fairly, equitably and consistently in accordance with their value to the organizations and to help the organization to achieve its strategic goals.

It deals with the design, implementation and maintenance of reward systems which aim to meet the needs of both the organization and its shareholders.

The aims of compensation management are to design the lowest cost plan structure which will attract, motivate and retain competent employees and which will be perceived by these employees as fair.

What are fair wages or what is fair remuneration? Fairness is a term which frequently arises in the administration of an organization’s compensation programme, with a view to minimizing costs.


Compensation management, also known as wage and salary administration, remuneration management, or reward management, is concerned with designing and implementing total compensation package.

The traditional concept of wage and salary administration emphasized only determination of wage and salary structures in organizational settings.

Learn about:-

1. Introduction of Compensation Management 2. Meaning and Definition of Compensation Management 3. Concept 4. Objectives 5. Process 6. Factors Influencing 7. Functions 8. Principles Governing  9. Theories 10. Effectiveness 11. Compensation Management in India.

Compensation Management in HRM: Meaning, Definition, Concept, Objectives, Process, Factors, Functions and Theories



  1. Introduction of Compensation Management
  2. Meaning and Definition of Compensation Management
  3. Concept of Compensation Management
  4. Objectives of Compensation Management
  5. Process of Compensation Management
  6. Basic Factors Influencing Compensation Management
  7. Functions of Compensation Management
  8. Principles Governing Compensation Management
  9. Theories of Compensation Management
  10. Compensation Management Effectiveness
  11. Compensation Management in India

Compensation Management – Introduction

Compensation to employees means remuneration to employees for the services rendered by them to the organisation. In other words, remuneration is the compensation an employee receives in return for his or her service to the organization. Remuneration or reward or salary or wages paid to an employee plays a very important role in his or her life because his or her standard of living, status in the society, motivation, loyalty and productivity depend upon the remuneration received by him or her.

For the employer of organization or management also, employee compensation or employee remuneration is significant because of its contribution to the cost of production. In addition, many frictions take place between the employer (management or organization) and the employees on issues relating to wages or bonus or pension or provident fund.

For the HRM, employee remuneration is a very important function since every employee is mainly concerned with the amount of remuneration, scale, and other allowances that he or she receives. Every employee desires to get as much as possible higher remuneration whereas every organization desires to give as less as possible. The specialist of human resource management has a difficult task of fixing fair wages and wage differentials acceptable to employees and their leaders.


What is meant by fair wages? How much an employee should be paid? The search for an answer to this question throws directly into the topic of compensation management.

The aims of compensation management are to design the lowest cost plan structure which will attract, motivate and retain competent employees and which will be perceived by these employees as fair. What are fair wages or what is fair remuneration? Fairness is a term which frequently arises in the administration of an organization’s compensation programme, with a view to minimizing costs.

Organizations generally seek to pay the least that they can do. Therefore, from the point of view of the organization, fairness, means a wage or salary which is adequate to meet the demands and requirements of the job. But fairness, of course, is not a one-way approach, it is a two-way approach. Employees also want to get fair compensation. Therefore, from the point of view of the employees, fairness means sufficiently higher or adequate compensation, so that they are generally satisfied with the wage or salary they receive.

According to the equity theory, if employees perceive any imbalance in the relation of their input-outcome ratio to some comparative standard, they will act to correct the inequity. Thus, the search for fairness is pursued by both the employers and the employees.


It is essential to know more about compensation. Compensation to be paid to the employees as a reward for their services generally comprises cash payments, which includes besides wages, pensions, bonus for good work, and shared profits. Compensation may also be in the form of promotion, additional increments, words of praise, etc.

The workers also derive some personal satisfaction as a compensation for a job will done by them. However, it is very difficult to outline and explain every aspect of the payment of compensation to the employees. In addition to wages, certain aspects of job compensation are such as job satisfaction, job content, job responsibility, job creativity etc. Various theories of wages or salaries have been formulated by taking into account the demand and supply analysis, job analysis, responsibilities of the job etc.

Compensation Management – Meaning and Definition

The literal meaning of ‘compensation’ is to counter balance. In the case of human resource management, compensation is referred to as money and other benefits received by an employee for providing services to his employer.

Money and benefits received may be in different forms-based compensation in money form and various benefits, which may be associated with employee’s service to the employer like provident fund, gratuity, insurance scheme, and any other payment which the employee receives or benefits he enjoys in lieu of such payment.


Cascio has defined compensation as follows:

“Compensation includes direct cash payments, indirect payments in the form of employee benefits and incentives to motivate employees to strive for higher levels of productivity”.

The term compensation is used to mean employees’ gross earnings in the form of financial rewards and benefits as a part of employment relationship.

Compensation may also be viewed as:


(a) A system of rewards that motivates employees to perform,

(b) A tool used by organizations to foster the values, culture and the behaviour they require, and

(c) An instrument that enables organizations to achieve their business objectives.

Compensation is typically divided into direct and indirect components. Direct compensation refers to the monetary benefits offered and provided to employees in return of the services they provide to the organization.


The monetary benefits include basic salary, dearness allowance, overtime pay, shift allowance, incentive, house rent allowance, conveyance, leave travel allowance, medical reimbursements, special allowances, bonus, provident fund/ gratuity, profit sharing bonus and commissions, etc. They are given at a regular interval at a definite time.

Indirect compensation refers to non-monetary benefits offered and provided to employees in lieu of the services provided by them to the organization. They include leave policy, overtime policy, hospitalization, sick leave, insurance, leave travel assistance limits, retirement benefits, holiday homes and flexible timings, various other benefits and perks, etc.

Beach has defined wage and salary administration as follows- “Wage and salary administration refers to the establishment and implementation of sound policies and practices of employee compensation. It includes such areas as job evaluation, surveys of wages and salaries, analysis of relevant organizational problems, development and maintenance of wage structure, establishing rules for administering wages, wage payments, incentives, profit sharing, wage changes and adjustments, supplementary payments, control of compensation costs, and other related items.”

Compensation Management – Concept

Compensation management has become one of the issues both for employees and employers around the world due to its importance. Naturally, employees want to get more remuneration for their work as where employers want to pay as minimum as they can. So, regarding the compensation there is a conflict between employees and employers in many organizations.

Compensation or reward management is concerned with the formulation and implementation of strategies and policies which are to reward people fairly, equitably and consistently in accordance with their value to the organizations and to help the organization to achieve its strategic goals. It deals with the design, implementation and maintenance of reward systems which aim to meet the needs of both the organization and its shareholders.

Compensation management, also known as wage and salary administration, or remuneration management, is concerned with designing and implementing total compensation package.


The traditional concept of wage and salary administration emphasized only determination of wage and salary structure in organizational settings. However, over the passage of time, many more forms of compensation entered the business field which necessitated taking wage and salary administration in comprehensive way with a suitable change in its nomenclature.

Management of compensation also follows the same principles of managing the five functions and three resources effectively. The only difference is that more care is taken to manage the human resources as they manage other resources if they are adequately paid and cared for.

Organizational aims and objectives guide the HR policy which in turn guides the HRM to manage the compensation. The main objective of compensation management thus becomes to ensure worth and compatibility to the worker and the working environment, and to observe internal and external equity so as to ensure that the workers are satisfied and are willing to work whole-heartedly.

The HRM Manager has to design the strategy to attract the most appropriate employees and manage the policy within the government’s legislations and the union’s satisfaction. For this, it may manage the functions through various committees or divisions.

Compensation Management – Top 5 Objectives: General Objectives, Employer’s and Employee’s Objectives and a Few Other Objectives

The compensation system is designed to achieve certain objectives. Though the main objective of compensation management is to attract competent personnel, minimize the conflict, encourage the employees to perform better, and have a culture and policies to retain them, it aims at treating the employees as an asset to the organization and properly maintains them, to retain them and keep satisfied.

I. General Objectives:

The establishment of equity is an important objective of compensation management.


However, the general objectives of compensation management could be listed as below:

General Objectives:

i. To attract and acquire qualified and competent employees to meet the organizational objectives

ii. To secure internal and external equity

iii. To control the desired behaviour of the employees

iv. To reduce conflicts and grievances


v. To ensure industrial harmony

vi. To simplify minimum bargain

vii. To facilitate pay roll and pay system.

Every organization has a goal to accomplish and an urge to develop competitiveness, and therefore tries to acquire and retain the talents by designing and offering attractive compensations. To accomplish this task both the employer’s and the employee’s objectives regarding the compensation and the internal as well as the external environment need to be analyzed.

II. Employer’s and Employee’s Objectives:

Employer’s Objectives

The main objective of the employer is to acquire competent employees at reasonable costs to the company.


Other objectives could be:

(i) To justify the cost to the company through performance and productivity improvement

(ii) To ensure industrial harmony by satisfying the worth of the employees

(iii) To comply with legal rules

(iv) To boost the morale of the employees.

Employee’s Objectives:


The employee’s objectives are aimed at equity-based compensation, fair evaluation of their worth, comfort at the work place and commitment of adequate cushion for inflation and better performance.

Thus, the employee’s objectives are:

1. To get equity based remunerations

2. To satisfy their worth

3. To have cushion for price inflation

4. To have security and welfare considerations.

III. Objectives to Cover Environmental Factors:

Compensation management and policy should also cover the objectives in the economic, social, political and legal contexts as well as the objectives of employers and employees.

1. Economic Objective:

The basic economic objective of compensation is to maximize the national income and it should be divided equally among all the members of the economy. The second objective is to maximize the welfare to attain the highest and the most stable standard of living possible for each section of the society.

In order to secure this objective, it is necessary to:

(i) Have a full employment objective

(ii) Highest degree of economic stability and

(iii) Maximum income security for all sections of the community.

For this the organization should aim at:

a. Justification of cost of human capital

b. Justification of performance based equity

c. Ensuring industrial harmony

d. Compliance of Government legislations to control socio-economic upliftment

e. Boosting the morale of the employees.

2. Social Objective:

Compensation is inter-related with broader economic decisions, on the one hand, and with the goal set for societal development, on the other hand. Compensation categorizes the occupation level and status of an individual in the society. But society also emphasizes equal or fair compensation, elimination of exceptionally low wages and protection of the wage earner from inflation.

Thus the social objectives can be surmised as:

a. Ensuring substantial wage/salary and fairness

b. Meeting standard of living

c. Providing employment

d. Protection of the wage earner from inflation.

3. Political Objective:

Every government and the ruling party has to ensure no sweating of any labour and per capita income which force them to focus on the earning compatibility with the economic growth of the region/state or the nation.

Thus, the political objectives can be summarized as:

a. To avoid exploitation or sweating of the workers

b. To control the per capita income and provide fair employment

c. To ensure economic growth of the state or the nation.

IV. Views of Experts from Different Disciplines:

Different experts from different discipline like Economists, Socialists, Psychologists, Management Practitioners, however have different views on compensation.

i. Economists – Economists consider compensation as a factor of production and view national productivity, means of earning, savings, and purchasing power for economic growth considerations.

ii. Socialists – In a society, compensation is viewed as an index of living standards, the status of an individual in a society and overall social development.

iii. Psychologists – Psychologists view compensation as a means for individuals to satisfy their basic security, psychological and personal needs.

iv. Management Practitioners – For management practitioners compensation is a tool to attract talents, view their worth with respect to the cost to the company and to harness the best from the employees.

V. HRM, Competitive Advantage and Compensation Objectives:

The prime duty of human resource management is to optimize the best use of human resources, and to encourage and motivate the employees to increase the effectiveness of their potentials, which helps the company to develop a competitive advantage.

Compensation here plays an important role to make the employees comfortable, energetic, enthusiastic and motivated to do their best for the organization.

Traditional Compensation Module for HRM:

Traditionally compensation is viewed as the worth of the employee and his/her expectations from the job and the company. On the other hand, the employer tries to weigh the compensation with market trends, supply and demand elasticity and internal factors affecting the cost of human resources.

The employer therefore pays compensation in two parts – (a) Direct payments and (b) Indirect payments. However, the employer cannot ignore the work culture which motivates the employees, and job security as well as retiring benefits to the employee.

External influences refers to market value of role, competitiveness in hiring, changing profile and expectations of employees, legal and political complaints to hire and maintain employees and zonal criteria of employment and minimum wage/salary levels.

Internal environment to be analysed in contest to need of compensation differentiations, changes of roles and authorities in him/her with compensation packages, need or restructuring or reengineering and outsourcing.

Work environment play important role in harnessing the potential or energies of employees and help in compromising direct compensation to the employees. Freedom to work or use creativity, indirectly help the potential employees to earn more by self-achievement motivation.

Compensation satisfaction has sensible dimension of job security and opportunities to plan career. This aspect one more complex in designing satisfactory compensation.

Compensation Management – Sequential Steps of the Process: Organization’s Strategy, Compensation Policy, Job Analysis and Evaluation & Few More Steps

In order to achieve the objectives of compensation management, it should proceed as a process. This process has various sequential steps.

Step # 1. Organization’s Strategy:

Organization’s overall strategy, though not a step of compensation management, is the starting point in the total human resource management process including compensation management. Companies operating in different types of market/product having varying level of maturity, adopt different strategies and matching compensation strategy and blend of different compensation methods.

Thus, it can be seen that organizations follow different strategies in different market situations and align their compensation strategy and contents with these strategies. In a growing market, an organization can expand its business through internal expansion or takeover and merger of other organizations in the same line of business or a combination of both.

In such a growing market, the inputs, particularly human resources, do not grow in the same proportion as the business expands. Therefore, in order to make the growth strategy successful, the organization has to pay high cash to attract talents. For example, information technology is a fast growing business presently and we find maximum merger and higher managerial compensation in this industry.

In mature market, the organization does not grow through additional investment but stabilizes and the growth comes through making the present investment more effective, known as learning curve growth. In such a situation, average cash and moderate incentives may work.

The benefits which have been standardized have to be maintained. In the declining market, the organization has to harvest profit through cash generation and cost cutting and this cannot be sustained over the long run, the possible retrenchment of business to invest somewhere else. In such a case, compensation strategy involves cost control with below average cash and incentive payments.

In viewing the compensation from strategic point of view, the companies do the following:

(i) They recognize remuneration as a pivotal control and incentive mechanism that can be used flexibly by the management to attain business objectives.

(ii) They make the pay system an integral part of strategy formulation.

(iii) They integrate pay considerations into strategic decision-making processes such as those that involve planning and control.

(iv) They view the company’s performance as the ultimate criterion of the success of the strategic pay decisions and operational remuneration programmes.

Step # 2. Compensation Policy:

Compensation policy is derived from organizational strategy and its policy on overall human resource management. In order to make compensation management to work effectively, the organization should clearly specify its compensation policy, which must include the basis for determining base compensation, incentives and benefits, and various types of perquisites to various levels of employees.

The policy should be linked with the organizational philosophy on human resources and strategy. Besides, many external factors which impinge on the policy must also be taken care of.

Step # 3. Job Analysis and Evaluation:

Job analysis provides basis for defining job description and job specification with the former dealing with various characteristics and responsibilities involved in a job and the latter dealing with qualities and skills required in job performer. Job analysis also provides base for job evaluation which determines the relative worth of various jobs in the organization. The relative worth of various jobs determines the compensation package attached with each job.

Step # 4. Analysis of Contingent Factors:

Compensation plan is always formulated in the light of various factors, both external and internal, which affect the operation of human resource management system. Various external factors are conditions of human resource market, cost of living, and level of economic development, social factors, pressure of trade unions, and various labour laws dealing with compensation management.

Various internal factors are organization’s ability to pay and employees’ related factors such as work performance, seniority, skills, etc. These factors may be analyzed through wage/salary survey.

Step # 5. Design and Implementation of Compensation Plan:

After going through the above steps, the organization may be able to design its compensation plan incorporating base compensation with provision of wage/salary increase over the period of time, various incentive plans, benefits and perquisites.

Sometimes, these are determined by external party, for example, pay commissions for Government employees as well as for public sector enterprises. After designing the compensation plan, it is implemented. Implementation of compensation plan requires its communication to employees and putting this into practice.

Step # 6. Evaluation and Review:

A compensation plan is not a rigid and fixed one but is dynamic since it is affected by a variety of factors which are dynamic. Therefore, compensation management should have a provision for evaluating and reviewing the compensation plan.

After implementation of the plan, it will generate results either in terms of intervening variables like employee satisfaction and morale or in terms of end-result variables like increase of productivity. However, this latter variable is more important. The evaluation of compensation plan must be done in this light. If it does not work as intended, there should be review of the plan necessitating a fresh look.

Compensation Management – Basic Factors: The Organizations Ability to Pay, Supply and Demand of Labour, Prevailing Market Rate and a Few Other Factors

A sound wage policy is to adopt a job evaluation programme in order to establish fair differentials in wages based upon differences in job contents.

Beside the basic factors provided by a job description and job evaluation, those that are usually taken into consideration for compensation management are:

(a) The Organizations Ability to Pay:

Payment of wages depends upon the affordability of an organization. Companies that have good sales and, therefore, high profits tend to pay higher those which running at a loss or earning low profits because of higher cost of production or low sales.

If the firm is marginal and can’t afford to pay higher than the competitors then the employees will go to other firms while if the company is successful then they can easily pay their employees as they wish. All employers, irrespective of their profits or losses, must pay not less than their competitors and need to pay more if they wish to attract and retain workers.

(b) Supply and Demand of Labour:

The labour market conditions or supply and demand forces operate at the national, regional and local levels determine organizational wage structure and level. If the demand for certain skills is high and supply is low, the result is a rise in the price to be paid to these skills.

The other alternative is to pay higher wages if the labour supply is scarce; and lower wages when it is excessive. Similarly, if there is a great demand for labour expertise, wages rise; but if the demand for manpower skill is minimal, the wages will be relatively low.

(c) Prevailing Market Rate:

This is known as the ‘comparable wage’ or ‘going wage rate’, and is the widely used criterion. An organization’s compensation policy generally tends to conform to the wage rate payable by tine industry and the community. This is done for several reasons.

First, competition demands that competitors adhere to the same relative wage level. Second, various Government laws and judicial decisions make the adoption of uniform wage rates as attractive proposition.

Third, trade union encourages this practice so that their members can have equal pay, equal work and geographical differences may be eliminated. Fourth, functionally related firms in the same industry require essentially the same quality of employees, with same skill and experience.

This results in a considerable uniformity in wage and salary rates. Finally, if the same or about the same general rates of wages are not paid to the employees as are paid by the organization’s competitors, it will not be able to attract and maintain the sufficient quantity and quality of manpower.

(d) The Cost of Living:

The cost of living pay criterion is usually regarded as an automatic minimum equity pay criterion. This criterion calls for pay adjustments based on increase or decrease in an acceptable cost of living index. However, when living costs are stable or decline, the management does not resort to this argument as a reason for wage reductions.

(e) Labour Union:

Labour union also helps in paying better wages to the workers. Higher wages have to be paid by the firm to its workers under the pressure of the trade unions.

(f) The Living Wage:

It implies that wages paid should be adequate to enable an employee to maintain himself and his family at a reasonable level of existence. However, employers do not generally favour using the concept of a living wage as a guide to wage determination because they prefer to base the wages of an employee on his contribution rather than on his need.

(g) Government:

Government has also fixed the rules for protecting the interest of the employees. The organizations are liable to pay as per the Government instructions. Wages cannot be fixed below the level prescribed by the Government.

(h) Productivity of Workers:

To get the best results from the employees and to increase the productivity, compensation has to be linked with productivity.

(i) Skill Levels Available in the Market:

With the rapid growth of industries, business and trade, there is shortage of skilled resources. The technological development and automation have been affecting the skill levels at faster rates. Thus, the wage levels of skilled employees are constantly changing and an organization has to keep its level up to suit the market needs.

Compensation Management – 4 Main Functions: Equity, Welfare, Motivation and Retention Function

Compensation management’s objective is to hire competent persons, to ensure the internal and external equity concept to improve employee’s satisfaction and to retain these valuable human resources or assets.

The main functions of compensation management are:

(1) The Equity Function

(2) The Welfare Function

(3) The Motivation Function

(4) The Retention Function.

(1) The Equity Function – It is the first and foremost important function of compensation which ensures that the employees are fairly paid and that their worth is appropriately compared. This function ensures that more difficult jobs are paid more and that they are fairly compensated in comparison to similar jobs in the market.

(2) The Welfare Function – This function is to take care of their psychological and social need satisfaction. The employees worry about the family, and the liability should be reduced and their self-esteem needs should be met to allow them to work without tension or unwanted stresses.

(3) The Motivation Function – The motivational function is to encourage an employee to take further challenges, perform better and develop oneself for superior positions. This function, therefore, takes care of career plans and training and development activities.

(4) The Retention Function – Today, human resources are being considered as a valuable asset to the organization and because of retaining and developing the knowledge bank, the retention of employees has become an important function of compensation management.

HRM manager thus endeavour to take care of above functions in managing the compensation to develop employees satisfaction and to fulfil employer’s objective.

Compensation Management – Generally Accepted Principles Governing the Fixation of Compensation

The generally accepted principles governing the fixation of compensation are as follows:

(i) 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.

(ii) The general level of wages and salaries should be reasonably in line with that prevailing in the labour market. The labour market criterion is most commonly used.

(iii) The plan should carefully distinguish between jobs and employees. A job carries a certain wage rate, and a person is assigned to fill it at that rate. Exceptions sometimes occur in very high level jobs in which the job holder may make the job large or small, depending upon his ability and contribution.

(iv) Equal pay for equal work, i.e., if two jobs have equal difficulty requirements, the pay should be the same, regardless of who fills them.

(v) An equitable practice should be adopted for the recognition of individual differences in ability and contribution.

(vi) There should be a clearly established procedure for hearing and adjusting wage complaints. This may be integrated with the regular grievance procedure, if it exists.

(vii) The employees and the trade union should be informed about the procedure used to establish wage rates. Every employee should be informed of his own position, and of the wage and salary structure. Secrecy in wage matters should not be used as a cover up for haphazard and unreasonable wage programme.

(viii) The wage should be sufficient to ensure for the worker and his family reasonable standard of living. Workers should receive a guaranteed minimum wage to protect them against conditions beyond their control.

(ix) The wage and salary structure should be flexible so that changing conditions can be easily met.

(x) Prompt and correct payments of the dues of the employees must be ensured and arrears of payment should not accumulate.

(xi) For revision of wages, a wage committee should always be preferred to the individual judgement.

(xii) The wage and salary payment must fulfil a wide variety of human needs, including the need for self-actualization. It has been recognized that money is the only form of incentive which is wholly negotiable, appealing to the widest possible range of seekers. Monetary payment often acts as motivation and satisfies interdependently of other job factors.

Desire to maintain or enhance the company’s prestige has been a major factor in the wage policy of a number of firms. Desires to improve or maintain morale, to attract high caliber employees, to reduce turnover, and to provide a high living standard for employees as possible also appear to be factors in management’s wage policy decisions.

Compensation Management – 2 Important Theories: Traditional and Contemporary Theory

There are various theories of compensation, also known as theories of wages or employee remuneration. These theories may be put into two broad categories- traditional theories and contemporary theories.

I. Traditional Theories:

Traditional theories are based on mostly economic considerations. Though there are many traditional theories of wages, major traditional theories are subsistence theory, wages fund theory, and residual claimant theory, Let us have a brief discussion of these theories.

1. Subsistence Theory:

According to this theory, wages in the long term would be equal to what is required for subsistence of workers- food, clothing, and shelter. This is also known as the Iron Law of Wages. David Ricardo, who propounded this theory, believed that if wages were more than what was required for mere subsistence, it would be temporary because prosperity of the workers would soon increase the population and, hence, the labour supply.

This would depress wages and bring them down to the level of subsistence. Similarly, wages below the subsistence level would starve certain workers; others would not marry. This will reduce the supply of workers and raise wages.

The subsistence theory is criticized on the following grounds:

i. The theory assumes that the supply of labour is inelastic which is wrong.

ii. The assumption that increase in wages will increase the size of the labour force is wrong because there is no direct relationship between level of income and family size.

2. Wages Fund Theory:

J.S. Mill, who propounded this theory, has maintained that a certain fixed proportion of the capital of a country is set apart for payment to labourers as wages. He called this proportion as wages fund. Thus, according to him, wages at any moment are determined by the amount of money in the wages fund and the total number of labourers in the country.

If the fund remains constant and the supply of labour increases, wages would fall, and vice versa. It is implied that if wages are forced up, capital will leave the country.

This theory is criticized on the following grounds:

i. The theory does not explain how the wages fund is created.

ii. It does not explain differences in wages in different occupations.

iii. According to this theory, there is always conflict between amount of wages and profit. This is not true because in prosperity, amount of both wages and profit increases.

3. Residual Claimant Theory:

Residual claimant theory, propounded by Francis Walker, states that wages are the remainder of total industrial revenue after deduction of amount of rent, interest, and profit. Thus, wages are determined after rent, interest, and profit.

This theory is criticized on the following grounds:

i. It is not the worker who is the residual claimant but the entrepreneur is the residual claimant. Therefore, profit is determined after deducting the amount of wages, rent, and interest.

ii. This theory does not explain how trade unions are able to raise wages.

II. Contemporary Theories:

Contemporary theories of wages take into consideration human behaviour in determining wages. There are four major contemporary theories- reinforcement theory, expectancy theory, equity theory, and agency theory. Let us go through these theories.

1. Reinforcement Theory:

Reinforcement theory, based on Skinner’s behaviour modification model, suggests that people’s behaviour that has positive consequences is repeated while the behaviour that has negative consequences is not repeated. Reinforcement is anything that strengthens or encourages someone’s behavioural response in a given situation.

In the case of employee remuneration, reinforcement is the amount of remuneration (including financial incentives) is the reinforcement. Therefore, amount of remuneration should be such that motivates the employees to engage in productive behaviour.

2. Expectancy Theory:

Like reinforcement theory, expectancy theory also relates effort and reward though process is different. Vroom, who has proposed expectancy theory, states that people will be motivated to do things to achieve some goals on the expectation that their certain actions will help them to achieve the goals. This theory is built around the concepts of valence, instrumentality, and expectancy.

Valence means the strength of an individual’s preference to a particular outcome. For example, higher remuneration (in terms of performance-based pay or skill-based pay) is an outcome which is valuable to an employee. Instrumentality is the first-level outcome in obtaining a derived second-level outcome.

For example, assume that the employee desires higher remuneration and feels that acquiring superior skills is a very strong factor in achieving higher remuneration.

In this case, acquiring superior skills is the first-level outcome and higher remuneration is the second-level outcome. Expectancy is the probability that a particular action will lead to a particular first-level outcome. For example, the employee may find out the probability of acquiring superior skills.

If he perceives that there is high probability that he may be able to acquire superior skills, he will be willing to put those efforts. In the alternative case, he will not be willing to put the efforts. Generally, organizations design their remuneration systems based on the precepts of this theory.

3. Equity Theory:

Equity theory is based on the social exchange process. Adams, who has propounded equity theory, points out that people are motivated to maintain fair relationship between their performance and reward in comparison to others.

There are two assumptions on which the theory works- (i) Individuals make contributions in the form of job performance for which they expect certain rewards in the form of remuneration. (ii) They analyze whether a particular exchange is satisfactory or not by comparing their contributions and rewards with those of others and try to rectify any inequality.

This comparison may be either internal (within the organization) or external (outside the organization). Equity is calculated through dividing contributions by rewards. If there is equity, the person concerned remains satisfied. In case of inequity (contributions being more than rewards), he tries to find out means to overcome inequity. “Equal pay for equal work” principle is based on this theory. Thus, employee remuneration should be fair and equitable.

4. Agency Theory:

In general terms, an agency is the relationship between two parties in which one is a principal and the other is an agent who acts on behalf of the principal. For performing agency work, the principal pays remuneration to the agent which is known as agency cost. In the context of wage determination, employer is the principal and employee is the agent.

Wage paid to the employee is his remuneration while it is agency cost to the employer. In the exchange process between employer and employee, the employer tries to minimize agency cost while employee tries to maximize it. The equilibrium is reached through negotiation between the employer and the employee keeping in view the relevant factors which affect wage pattern.

Compensation Management – Effectiveness (With Ways for Effectively Resolving Compensation Disputes)

A compensation policy matched with the external and the internal environment is the main guideline in managing the compensation system. However, the political, social and economic considerations and the union’s strength need to be analysed before designing management strategies.

The effectiveness of compensation management will depend on the following:

i. Scrutinize the market survey and develop compensation plans.

ii. Keep in view the competency and span of control depending upon the size, technology used and product or service lines.

iii. Focus on contributions and a collaborative approach rather than job content.

iv. Prepare the roles and responsibilities in line with compensation factors like competence, experience and personality attributes.

v. Keep and watch on changing patterns and changing expectations of the employees.

vi. Design more transparent and measurable performance appraisal systems.

vii. Periodical review of compensation policy, programmes and the changing needs.

Effectively Resolving Compensation (W/S) Disputes:

Whatever precautions or considerations are taken to fix compensation disputes cannot be overruled in any organization or establishment, because of the fast changing business environment, competitions, changing concepts and perceptions about compensation and, of course, the changing socio-economic factors.

Conflicts arise due to wage and salary disputes regarding wage differentiations, target setting and capacity of the individual, target linked payments, promotions or increments, rise in DA or total packages due to the rising cost of living, etc. These may demoralize the employees and may result in a slow down or a negative perception about the seniors or the management.

Therefore, to manage the industrial harmony, desired productivity and satisfactory interpersonal relationship with the employees, an effective method of conflict resolution is needed in any organization as an effective management tool.

Compensation Management in India

With the technological developments taking place at a higher rate, the salary packages are also increasing at a much higher rate. The compensation package comprises of monetary and non­monetary benefits that includes salary, special allowances, house rent allowance, travel allowance, mobile allowance, employee stock options, club memberships, accommodations, retirement benefits and other benefits.

Globalization is being considered as the cause for such salary hikes. The establishment of multinational companies and privatization has led the Indian industry to witness higher salary package. With the immense competition of attracting and retaining talented human resource, compensation package is the only motivation factor available with the organizations be it Indian origin organizations or foreign-owned multinationals.

With the high attrition rate, organizations are increasing their salary packages to attract and retain talented human resource. In the race, India has begged first position followed by Lithuania and China.


During the last two decades, the compensation philosophy and, indeed, the compensation structure of Indian organizations, have undergone radical change. It is not surprising that the reason for this change is the growth in information technology-enabled services (ITES) and, more recently, in the business process outsourcing (BPO) industry.

1. Current Trends:

It is interesting to track the changes in the Indian compensation scene.

Some changes are noted below:

i. Compensation is now viewed as the total “cost to company,” (CTC) rather than an employee’s net pay alone. As the environment gets competitive, such an approach helps organizations to take a holistic view of what could be the costs and the operating margins.

ii. Variable pay based on individual performance is the norm, and a larger percentage of the Indian salary is based on performance.

iii. Organization performance also is factored in while structuring salary increases.

iv. Some organizations also have implemented highly evolved systems, such as the “economic value added” (EVA) framework, ensuring a performance-oriented culture throughout the organization applicable to all employees.

v. Basic, guaranteed pay has seen a gradual reduction.

vi. Benchmarking against organizations, both nationally and internationally, has become common.

vii. Employee stock options (ESOPs) that were, a few years back, considered as valuable compensation components have ceased to be so given the erratic nature of the stock market and the lock-in periods.

viii. Non-taxable benefits, which increased the net “take-home” of an employee, are now subject to the Fringe Benefits Tax (FBT), and so organizations are forced to take second looks at these components.

ix. Retirement benefits are left to what is mandated by the government. Organizations that were contributing to a superannuation fund for the employee now have to pay the FBT.

x. Pension benefits and other similar social security benefits are not on the radar screen of compensation experts in India today, but this component could be under significant discussion and speculation in the coming years.

2. Fringe Benefits Tax:

The FBT has been in the spotlight for a long time and has been a cause for a lot of debate ever since the budget and Finance Bill was released last financial season by the Indian finance minister. However, viewed holistically, it is indeed in line with practices followed worldwide.

The taxation of perquisites or fringe benefits provided by an employer to his or her employees, in addition to the cash salary or wages paid, is fringe benefits tax.

Any benefits or perks that employees get as a result of their employment are to be taxed, but in this case, in the hands of the employers.

3. Social Security and Retirement Benefits:

The government of India provides for two mandatory contributions from the employer for the purposes of providing support to the employee and must be part of the overall individual compensation.

i. Provident Fund:

The Constitution of India, under “Directive Principles of State Policy,” provides that the state shall, within the limits of its economic capacity, make effective provisions for securing the right to work, to education, and to public assistance in cases of unemployment, old-age, sickness and disablement, and undeserved want.

The Employees’ Provident Fund & Miscellaneous Provisions Act, 1952, was enacted by parliament and came into force in March 1952.

Presently, the following three schemes are in operation under the act:

The Employees’ Provident Fund Scheme, 1952; the Employees’ Deposit Linked Insurance Scheme, 1976; and the Employees’ Pension Scheme, 1995. The Employees’ Provident Fund Organization, India, in New Delhi is one of the largest provident fund institutions in the world in terms of members and volume of financial transactions that it has been carrying on.

ii. Payment of Gratuity:

Gratuity is payable to an employee after he or she has rendered continuous service for not less than five years and when he or she either resigns or is terminated or has been rendered disabled due to accident or disease. It is paid to an individual nominated by the employee in case of his or her death. The maximum amount that can be paid as gratuity is prescribed by law.

iii. Employee State Insurance Corporation (ESIC):

The promulgation of the Employees’ State Insurance Act (ESI), 1948, envisaged an integrated, need-based social insurance scheme that would protect the interest of workers in contingencies that result in loss of wages or earning capacity such as sickness, maternity, temporary or permanent physical disablement, or death from employment injury.

The act also guarantees reasonably good medical care to workers and their immediate dependents, and the benefits provided to the employees under the act are in conformity with international labour organization (ILO) conventions. In addition, the scheme also provides some other need-based benefits to insured employees. These include rehabilitation allowance and vocational rehabilitation.

The scheme prescribes a wage ceiling and is applicable only to those employees whose compensation is within this ceiling. The act covers a large number of employees and has more than 30,701,300 beneficiaries. An interesting feature of the ESI scheme is that the contributions are related to the paying capacity as a fixed percentage of the workers’ wages, whereas they are provided social security benefits according to individual needs without distinction.

However, because the ESI is provided only to employees whose salary is within the ceiling, it cannot cover those earning higher wages and hence the coverage of this specific benefit is predominantly restricted to the blue-collar employees.