Compensation and pay are not synonymous terms. Compensation or remuneration refers to all the extrinsic rewards employees receive in exchange for their work. Pay refers only to the actual shilling, dollar, pound that employees receive in exchange for their work. Usually compensation is seen as consisting of the base wage or salary, any incentives or bonuses and any benefits.
Incentives are rewards offered in addition to the base wage or salary and are usually directly related to performance. Benefits are rewards employees receive as a result of their employment and position with the organization.
A reward system consists of financial rewards (fixed and variable pay) and employee benefits, which together comprise total remuneration. Total remuneration is the value of all cash payments (total earnings) and benefits received by employees.
A compensation package consists of two kinds of payments, during employment and after employment. The during employment package consists of; the basic salary, cash allowances, bonus and non-cash perquisites. After employment compensation is in the form of pension, gratuity, limited medical facilities and purchases from cooperative society.
Theoretical considerations
A number of economists have propounded theories, which assert the following: –
- That, the natural price of labour is the subsistence – level wage. Higher wages increase labour supply while low wages below subsistence level may make people to die of disease and malnutrition.
- That there is a predetermined fund (surplus income) which decides the wages
- That workers will never receive full compensation, and that wages constitute an inadequate payment for the surplus value created by the workers to the employer
- That state has to manipulate the allocation of income to wage earners to restore full employment
- That cheap labour will be a basis for comparative cost advantage in international trade
COMPONENTS OF A REMUNERATION PACKAGE
A remuneration package consists of the following: –
- Base pay/basic salary
- Allowances
Bonuses
- Incentives
- Commission
- benefits
Perquisites
Basic Salary
This is the major component of employment compensation package. Basic salary is worked out on the basis of job evaluation, and is adjusted either because of reclassification or changes in the cost of living index. Basic salary is a range with top and base clearly defined.
Basic salary is the fixed salary or wage, which constitutes the rate for the job. For manual workers it may be referred to as time or day rate. It may provide the platform for determining additional payments related to performance, competence or skill. It may also govern pension entitlements and life insurance when they are related to pay.
The base rate for a job is regarded as the rate for a competent or skilled person in a job. The basic levels of pay for jobs reflect both internal and external relativities
Internal relativities may be measured by some form of job evaluation, which places jobs in a hierarchy. External relativities are assessed by tracking down market rates. Pay levels may also be agreed upon via negotiations i.e. CBA’s or by individual agreements.
In many organizations pay rates are fixed by managerial judgment of what is required to recruit and retain people. The rates may get adjusted due to individual or collective pressures for increases or upgrading.
The base pay may be expressed as an annual, weekly or hourly rates and may be adjusted to reflect increases in the cost of living, market rates, agreement with unions or unilaterally by the management.
Allowances
Some of the well-known allowances include; house rent, travel allowance, daily allowance, hardship allowance, shift allowance, and so on. The concept of allowance is based on the cost of living index and are meant to compensate for the extra efforts needed for one to perform normal duties. Allowances can be added to the basic pay depending upon the contingencies of the job. The exact quantum of most allowances is usually linked to the basic salary as they present a percentage of the basic.
Bonus
This is a reward for good performance, which is paid in lump sum related to the results obtained by individuals, teams or the organization. Bonus is seen as profit sharing and focuses on improving productivity for both employer and employee.
Perquisites
Perks are those benefits that do not usually come in the form of cash but are provided to maintain certain needs and status of the employee, and image of the organization. These may include perks such as stock options, club membership, car or housing loans, reimbursement of the cost of children’s education, paid holidays, generous medical benefits, furnishing of residence and many others.
Incentives
These are payments linked to the achievement of previously set targets, which are designed to motivate people to achieve higher levels of performance. Targets are usually quantified as output, sales and so on.
Commission
A special form of incentive in which payments to sales staff are made on the basis of a percentage of the sales value they generate
FACTORS INFLUENCING REMUNERATION PACKAGE
Remuneration packages are subject to major influences internal and external to the job. These factors or what might be called “facts of life” for both employer and employee are as follows: –
- Labour Market Conditions.
Include the prevailing market rates for the cost of certain calibres of labour. Here organisations compare a job with similar jobs elsewhere in the market. It looks at what other people or organisations pay for the same or similar competency or job.
The labour market, like all other markets has buyers (employers) and seller (employees). It is in the external market that the economic determinants of pay levels operate. Pay levels in the labour markets are determined by supply and demand considerations. If supply exceeds demand the pay levels go down; if demand for labour exceeds supply at the market clearing or market equilibrium wage. This is known as the theory of equalizing differences.
In the internal market, the firm, pay progression may relate to the length of service and an annuity approach to apply increments (i.e. pay that goes up but does not come down – the sticky wage) and this may lead to higher internal rates. Pay in the internal market will also be affected by decisions on which individuals should be rewarded for their particular contribution, specialized expertise, irrespective of the market rate for their job.
The internal and external labour markets are concerned with, apart from supply and demand, the efficiency wage theory, human capital theory and agency theory.
The efficiency wage theory, proposes that firms will pay more than the market rates since they believe high levels of pay contribute to increase in productivity by motivating the worker, attracting better candidates, reducing turnover and persuading workers that they are treated fairly. The theory is also known as the ‘Economy of high wages’.
The Human Capital theory, states that investment in people adds to their value to the firm. The theory encourages the use of skill-based or competence related pay as a method of reward.
It also advocates the concept of individual market worth-that individuals have their own value in the market place which they acquire and increase through investments by their employer and themselves in gaining extra expertise and competence through training, developments and experience. Their market rate may be higher than the market rate for their jobs, and if not rewarded accordingly, they may market their talents elsewhere.
- Ability to Pay/Business Performance. An organisation can only honour its promises concerning pay if it is able to pay. Adequate pay is only possible on a healthy financial base. Employees need to understand a company’s financial position if their demands care to be realistic. Policies on salary reduction are common in a depressed economy. Hefty pay increases are only possible where the organisations financial performance is excellent. Organizations vary in their ability to meet their wage and salary commitments. Those, which have profitability and have a good cash flow, find it easier to be generous. Those that are struggling find it hard to meet even their minimum obligations.
- Pay levels will be determined by internal and external comparability. The remuneration paid out should be comparatively fair to what other jobs are getting in the organisation and outside.
- Bargaining strength of the Trade Union. Trade unions enter into agreements with employers and these agreements involve remuneration of the workers. Such agreements are contained in the CBA’s. They stay in force till the next round of negotiations. The ability of the trade union to influence pay decisions depends very much on its bargaining power. If the employer’s need for labour is desperate, or the skill required scarce, then the unions strength will be strong and may be enough to divert financial resources elsewhere to resent wage and salary demands. Where labour is plentiful or the organization is reducing its labour force via redundancies, the union strength is at its weakest.
- Cost of living Adjustments (COLA). This comes in the form of increased allowances to employees (COLA). It is a move to adjust the employee’s purchasing power against economic realities. Where COLA is given, it does not constitute or affect the basic salary, nor the schedules date for salary increment. Where an economy is under inflation, salaries for some organisations are increased by a factor of the inflation rate.
- Government action/legislation. These affect remuneration through; taxation and government policies on wages and employment. The higher the salary the more the taxation. Tax exemptions also affect remuneration. Wage guidelines set by the government state what are the minimum wages for employees. The upper limit is at the discretion of the employer. Some employers use this guideline to deny workers more remuneration. Government has relied on fiscal measures (taxation, interest rates, and exchange rates) to influence wage rates.
- Productivity of the company and the economy in general will have a bearing on the levels of salaries to be given to employees. Highly productive companies remunerate their workers well and the opposite is true. As long as there are markets (i.e. buyers) for goods and services, it is the efficiency with which these items are produced that determines whether prosperity can be received. Higher wages are possible to apply if there are improvements in productivity – improved output in relations to inputs.
- Existing differentials / custom and practice. In some companies remuneration levels continue to be determined by the existing differentials or the organisations culture, custom and practice. Wage-differentials are established on the basis of job evaluation, and may be as a response to the pressures of particular groups. Existing differentials and custom and practice are great influences to pay. Custom and practice refers to pay practices that have evolved over time and have come to be accepted.
- Organisational/technological change. Organisational processes such as BPR do influence remuneration levels by bringing into force new patterns of remuneration. Some hitherto poorly remunerated jobs may all of a sudden gain prominence and begin to command more remuneration. Other jobs may get downgraded and command less remuneration.
- An organization, which is in a stable condition, both internally and in relation to its external environment, is able to implement its pay and salary policy with relative ease. An organisation undergoing massive change, perhaps due to market pressures or technological change, will probably find that it has to completely restructure its payments system. Technology has led to a demand of renew skill s and new job definitions, while reducing the demand for many farmer skills and jobs.
- Individual’s performance. This is practiced where pay is tied to performance (performance related pay) and allows for increment based on performance.
- Company policy on remuneration.
- A policy of seeking to be a market leader will see a company also adopt market leader remuneration styles. In such a company remuneration will always remain above the market rates. Such policies may be based on the need to attract and retain the best, achieve internal consistencies in pay, pay and performance and external consistencies
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TOPIC 3: REWARD POLICY
A policy is a guideline that helps managers make day-to-day decisions. Reward policy is an organisations’ statement on the implementation of reward management and strategies required, to achieve the reward policy.
Among the key challenges in planning and administering a reward system are the policy issues.
A reward policy is a broad expression on how the organisation intends to reward its employees. Such statements usually cover certain aspects: –
- Basis of reward
- Market rates/internal rates reconciliation
- Line managers involvement
- Level of flexibility
- BASIS OF REWARD
This explains whether is to be based on performance for example, or based on seniority, or on skills etc
- MARKET RATE AND INTERNAL RATE RECONCILIATION
This explains the reconciliation of tension between the need to achieve external competitiveness and a reasonable degree of internal equity. Market rates especially competitor’s influence rewards. There is need for a balance between external tension and internal tension.
- LINE MANAGERS INVOLVEMENT
The policy needs to express the extent to which decisions on pay can be delegated to line managers. Involvement of line managers or no involvement should be defined by the policy. To get involved Line Managers must be adequately trained on techniques of decision-making as concerns reward management
- LEVEL OF FLEXIBILITY (Mix)
This explains the degree to which a flexible approach can realistically be adopted towards total remuneration. Address the extent to which one can mix basic salary and benefits selectively. An inflexible policy does not take care of all the employees’ interests.
DEVELOPING REWARD POLICIES
Reward policies are developed on the basis of the organisations reward philosophy. An organisation may have either a negative or a positive philosophy on reward.
A positive philosophy is that which is concerned with the level or quality of its remuneration. Such an organisation regularly reviews its package with an aim of attracting, retaining and motivating its workforce – it does not wait for a push or a threat to review its salary policies. Such a company is honest and it objectively remunerates employees – offers them what they deserve and not what it thinks.
A negative philosophy is seen in the form of dishonesty and subjectively in determining remuneration package. Such companies wait for a threat before they act on salary. Reviews are piece-meal with employee contribution to the company taken for granted.
Reward polices should be developed upon the understanding of the following: –
- Factors affecting performance and motivation
- Those factors affecting reward levels
- Factor affecting employee satisfaction with reward system
- The influence of corporate culture and organisation
FACTORS AFFECTING PERFORMANCE AND MOTIVATION
- i) Performance
For a high performance index to be achieved, the following should be considered: –
- Employee empowerment
- Employee guidance
- Employee empowerment – recognizes that the employees have the ability; skill and knowledge that is needed to achieve the level of competence required. Employees must be empowered to achieve full potential of their ability, skills and knowledge. Empowerment is done through, delegation of work and authority, but retaining responsibility, participatory management or participatory decision making process, allow for innovation and initiative, learn to accept errors as human.
- Guidance – this dictates that a supervisor or manager must be available when needed by the subordinate or staff. Absence may lead to frustration, reduced performance etc. it may lead to loss of many hours if not readily available.
- Employee should be enable to perform through guidance and support provided to them. Guidance is through quality of leadership and autonomy they are given to decide, act and exercise control over their work.
- ii) Motivation
This is an important factor in the development of rewards system. It is important to consider motivational factors before a decision is made on reward systems. Motivation may be based on various motivational theories, the most common being Influence of expectation theory
Expectancy Theory
Employees are likely to work harder based on their anticipation, that they can get the reward desired. This can only work under certain variables when the employee has skill is competent and that the target is attainable then this expectation theory can function.
Financial rewards work or act as incentives only if people’s expectations that they can earn the money is high. Money may not guarantee the employee’s improved performance.
- FACTORS AFFECTING REWARD LEVELS
- Individual worth – is concerned with the value of contribution made by individuals to the achievement of organizational goals. Such contribution must be quantifiable.
- External relativities – concerned with consideration for the values of the service to the buyer and seller the employer and the employee respectively.
- Internal relativities – this is concerned with the value of the job within the organization. Within an organisation pay levels are affected by real or perceived differences between the value of the jobs and the individual contributions made by the jobholders.
- Trade union pressure – this is done through the CBA’s. They use numerical strength to influence pay decisions – e.g. KNUT’s achievement of better pay for its members
- FACTORS AFFECTING EMPLOYEE SATISFACTION WITH REWARD SYSTEMS
The degree to which one is satisfied with the reward system is related to the following: –
- Fairness
- Expectation and value
- Internal comparisons
- External comparisons
- Self evaluation
- Total reward package
- a) Fairness
Is concerned with the extent to which the employees think the system is fair. This fairness can be seen, in that; rewards are commensurate with ability, contribution and effort. To be fair, pay must be felt to match the level of work and the capacity of the individual to do the work
- b) Expectation and value
Satisfaction is high when rewards meet expectations as to their value and the value of the reward is commensurate with the effort and skills to obtain it.
- c) Internal comparison
Employees are more likely to be satisfied if they feel they are being paid correctly in relation to what others gain for similar jobs in that organisation. Dissatisfaction may arise due to perceived inequities in pay levels
- d) External comparison
Unclear prediction of the levels of reward is likely to cause anxiety among employees – consequently, employee commitment and satisfaction may be eroded.
- e) Self evaluation
People always attach a level of value to what they believe they are worth. Satisfaction with rewards will result if the rewards are in line with what people believe they are worth. Self-evaluation should be considered with great caution because people have a tendency to over rate their own valuation
- f) Total reward package
Overall satisfaction depends on the result of a mix of rewards, rather than a single reward. A HR manager should carefully consider the reward mix. It is important to note that intrinsic benefits and extrinsic benefits are both valuable to employees.
- INFLUENCE OF CORPORATE CULTURE AND ORGANISATION
The reward system should fit the corporate culture. The organisation structure can influence reward system.
- A highly structured organisation – very bureaucratic, will tend to centralize its activities. A reward system in such a structure will be centralized and controlled from central point.
- A loose structure – explains how rapidly a company growing, may not wish to put in place overly formalized reward procedures. Such an organisation needs flexibility and as such the reward system will be flexible enabling the organisation respond quickly to change.
Flexibility may be seen in terms of remuneration mix, benefits available, and involvement of other managers in pay administration.
- A flattened structure or delayered structure requires better teamwork among managers. This will call of group rather than individual pay systems especially bonuses and incentives – encouraging teamwork and not individual performance.
- A highly decentralized structure – where authority is dispersed to lower levels of the organisation (employee empowerment) – the various units of the organisation are allowed to input to the decision making process concerning rewards. At times heads of departments may determine how much increment his/her employees should get the kind of benefits and the remuneration mix. Their recommendations on reward matters are taken seriously.
Such an organisation ay allow a fair degree of leeway to enable local management develop its own approaches to the reward system but within the broadly defined polices of the company.
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CONTENTS OF A REWARD STATEMENT
- Relationship of reward to performance
- Flexibility
- The levels of the reward
- Market rates
- Equity
- Performance related rewards
- Pay structure
- Delegation and control
- Balancing financial and non financial motivators
- The reward mix and the total package
- Communicating the benefits to employees
MANAGING REWARD TO IMPROVE RESULTS.
- Relate pay system to organizational needs and culture.
- Relate pay to contribution.
- Establish criteria and use it for assessing performance
- Evaluate jobs systematically.
- Monitor market rates.
- Allow flexibility
- Effective communication to explain the system and the reasons for it.
A SAMPLE REWARD POLICY
REWARD AND RECOGNITION POLICY
The Company encourages the recognition of excellent performance and achievement through the use of rewards that are creative, flexible, and meaningful. When administered and communicated effectively, reward and recognition are an important part of a total compensation program. Departments may choose whether or not to develop Defined Reward Programs. In the absence of a Defined Reward Program, departments may give rewards in immediate response to specific accomplishments.
The following are the content headings for the reward policy.
- Guiding principles
- Reward guidelines
- Defined reward program consultation process
- Implementation guidelines
- Department responsibilities
- Office of human resource responsibilities
- Payroll considerations
- The Law compliance
POLICY GUIDELINES
- Definitions
Reward – a one-time cash or non-cash award for significant outstanding performance.
Defined Reward Program – a documented reward program developed, communicated, and implemented in consultation with the Office of Human Resources (OHR) for a particular department. Defined Reward Programs consist of rewards that range from spontaneous to those that are more formal in nature.
- Guiding Principles
- Rewards should be given for significant outstanding performance that advances department goals, and should be tied to a specific accomplishment.
- Rewards are most effective when they are meaningful to the individual.
- Care should be taken in communication and distribution of rewards so that they are not viewed as entitlements.
- Rewards may be designed to reflect the unique nature of the department’s work culture and organizational structure.
- Rewards should not be substituted for a competitive salary plan. For example, rewards should not be used as a long-term alternative to permanent salary adjustments when these adjustments are appropriate for consistently high performance, significant changes in responsibility, increased value of a position, or internal pay equity.
- Rewards are not adjustments to base salary, supplemental compensation, or variable pay programs (such as commission).
- Rewards should not be used as a substitute for supplies, support services, or training.
III. Reward Guidelines
- These guidelines do not apply to customary work-related expenses such as travel, conference attendance, and memberships in professional organizations.
- Through the process of consultation and approval of Defined Reward Programs, parameters may be modified to meet individual college or department needs.
- Departments must consult with the Office of Human Resources, when cash distributions to an entire department are being considered. OHR approve such distributions prior to implementation.
- Defined Reward Program Consultation Process
Departments interested in creating a Defined Reward Program should notify the human resource contact, who will initiate the Defined Reward Program consultation process with the Office of Human Resources.
- Implementation Guidelines
- All Defined Reward Programs must be designed in consultation with the Office of Human Resources.
- The purpose, process, parameters, and expected outcomes of the reward program should be communicated in writing to staff.
- All expenditures must be consistent with company guidelines.
- Cash and non-cash awards should be determined in a manner that considers deductions such as taxes, and their effect on the net amount.
- Department Responsibilities
The Manager concerned will:
- Design reward programs that reflect company guidelines and department strategic plans.
- Seek consultation on the development and approval of Defined Reward Programs.
- Provide written communication about the purpose, process, and expected outcomes of the reward program to department staff.
- Implement reward programs in a manner that is consistent with the departments written guidelines.
- Fund reward programs, reflecting the realities of the company and department budget, and establish accountability within each department for use of funds.
III. Office of Human Resources Responsibilities
The Office of Human Resources will:
- Provide guidelines regarding reward program structure and processes.
- Serve as consultants to departments in developing reward strategies.
- Approve Defined Reward Programs.
- Oversee the use of reward programs.
- Serve as a clearinghouse for best practices.
- Process payroll taxes for cash and taxable non-cash awards.
- Payroll Considerations
- One-time cash rewards are administered through the additional pay panels of the HR System. Cheques are issued during the normal payroll cycle. If a check is needed outside of the normal cycle, a written Request for Off-Cycle Check must be sent to the Office of Human Resources, Payroll Services.
- All taxable non-cash awards must be reported to the Office of Human Resources through the additional pay panels in the HR System using the Non-Cash Award (NCA) earnings code. The appropriate taxes will be withheld from the individual’s paycheck.
- Tax Law Compliance
- Reward and recognition activities must be in compliance with all applicable tax laws. Before issuing awards, offices should work closely with the Office of Human Resources, to insure compliance.
- Under Kenyan tax laws, all compensation is subject to income tax unless there is a specific exemption. Following are common types of compensation that are exempt from income tax. It is important to properly classify compensation to avoid potential payroll tax liability for the company.
