6th Semester BBA Compensation and Performance Management

Module No. 1
Introduction to Compensation Management
Compensation

In the world of HR, compensation is what companies provide their workers in exchange
for their services, effort, skill, labor, time, and knowledge. Compensation could be given to
employees in the way of wages, salaries, benefits, bonuses, paid leaves, pension funds, stock
options, equities, or any other form of payment for their contribution towards the business's
growth. This blog helps readers understand the different types of compensation. HR professionals
can then create smart strategies and compensation structures that are appropriate and attractive to
potential employees. Attracting great talent is vital. It is also equally important to ensure that
business goals and strategies align with compensation structure and strategy.

Why is understanding different Types of Compensation Important?

Often sole traders or previously small companies that are experiencing rapid growth don't
have an experienced HR team. This means that their compensation packages aren't designed with
a strategy in mind.
Not having a solid compensation strategy and thereby failing to offer the right mix of types of
compensation to your employees can result in the following:
 Attrition
 De-motivation
 Reduced Productivity and therefore Reduced Profitability
 Lack of Satisfaction and Engagement
 Failure to Attract Top Talent
 Reduced Employee Loyalty

Types of Compensation
Let's look at the different types of compensation that could be offered to employees in this
section. The desired types of compensation differ across the globe. In countries where medical
expenses are relatively high, it is common to find that attractive health benefits make up a major
portion of their compensation.
There are two types of compensation:
1. Direct compensation (financial)
2. Indirect compensation (combination of financial and non-financial)
HR professionals, no matter the size of the organization they work for, have to have a clear
understanding of the different types of compensation. It is their duty to communicate the details
of the compensation package to candidates and new employees. Understanding the different types
of compensation also helps HR professionals when they have to conduct performance reviews and
give employees increments.
1. Direct compensation
Direct compensation refers to the payment made to an employee in the way of money or
finances. There are four main types of compensation that come under direct compensation:
 Hourly

Sangeetha K.K, Assistant Professor, Dept. of BBA, RJSIMS

6th Semester BBA Compensation and Performance Management

Gig-workers, unskilled labor, semi-skilled labor, temporary workers, part-time employees, or

contract workers often charge their employers by the hour. They get paid for the time they work,
irrespective of their output.
This can be seen in the fields of IT, construction, tourism, and logistics. When hiring labor for
hourly pay, employers typically inform them of how much time their services are required. In the
event that the time taken to execute the given task takes more time, hourly workers can often get
paid overtime. In most countries, strict minimum wage standards have to be adhered to.
 Salary
Full-time employees, skilled employees, and those who are in senior management positions
typically receive salaries. Having a fixed salary generally indicates that the employee's company
has plans to invest in this employee and work with them for the foreseeable future.
Some jobs that usually get paid in annual salaries are teachers, accountants, doctors, managers,
and so on.
 House Rent Allowance (HRA)
Company either provides housings facility or they provide house rent allowances to its employees.
 Dearness allowance
The payment of dearness allowance facilitates employees and workers to face the price increase
or inflation of prices of goods and services consumed by him.
 Leave Travel Allowance (LTA)
The employees are given allowances to visit any place they wish with their families.
 City Compensation Allowance
City compensation allowance is paid to the employees in certain cities to compensate the cost of
living. It varies from city to city & it is highest in metropolitan cities.
 Incentives
Incentives and variable compensation can be among the most important drivers of individual
performance. An incentive is something that motivates an individual for good perform.
A short term incentive (STI) is a common term and it is widely used in organisations. A STI is a
type of compensation that is provided to employees for achieving specific goals within a period of
one year or less. Sometimes STIs are also called variable pay because they depend on certain
events or performances.
Long-term incentives are a valuable part of a total compensation package both for delivering
rewards and focusing employees on desired future outcomes and objectives.
 Bonus
Bonus is paid to the employees during festive seasons to motivate them and provide them the social
security.
 Reward
something that is given in return for good or evil done or received or that is offered or given for
some service or attainment. Ex: the police offered a reward for his capture
Consolidated Pay
Consolidated pay means a total salary without any breakup, which means consolidated
salary is not divided into salary components like basic wage, HRA, transport & medical
allowances, etc. It can be paid on a weekly or monthly basis to the employees.
Commission
Commission is a common form of compensation provided to employees in sales roles. It
will usually be based on a predetermined quota or target. The higher the quota reached, the higher
the commission pay will be. Commission rates are often based on various specified factors,

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6th Semester BBA Compensation and Performance Management

including revenue and profit margins. Some employees will work on commission only or obtain
a salary with commission.
Indirect compensation
Indirect compensation is still a financial form of compensation since it has a financial
value. However, employees do not directly receive it in cash form. That’s why certain types of
indirect compensation are viewed as monetary, while others are deemed non-monetary. This often
varies between organizations.
Indirect compensation is often known as employee benefits or perks of the job.
Here are some common examples of indirect compensation.
 Equity package
Equity as part of a compensation package essentially means the employee is offered equity
(ownership) in the company, either through shares of stock or the option to buy such shares.
An equity package is common at start-up companies. These businesses may be low on cash or
funding and need other incentives to attract and retain employees.
 Stock options
This form of compensation entitles employees to purchase a set number of shares at a fixed price
after a certain period. This is different from an equity package because the employee will not have
any ownership in the company.
Many stock options require employees to work between three to five years before they can access
this compensation.
 Benefits
Typical employee benefits usually include health insurance, life insurance, retirement plans,
disability insurance, legal insurance, and pet insurance.
Healthcare is a common benefit in the US, as discussed, since it’s expensive to purchase.
Whereas, in the UK, healthcare is free on the NHS.
Retirement funds and pension plans are also common benefits that employees look for when
considering a new role at a new organization.
A survey found that 48% of job seekers in the US said they would be more likely to apply for
a job that came with good benefits. So although the base pay you offer is important, thinking about
your overall compensation package is essential.
Non-monetary compensation
Non-monetary compensation includes benefits like:
 Paid or Non-Paid Time Off
 Flexi-Time
 Learning and Development Opportunities
 Parental Leave
 Childcare
 Company Cars
 Phones or Laptops,
 Meals.
 Special Allowance
Special allowance such as overtime, mobile allowances, meals, commissions, travel expenses,
reduced interest loans; insurance, club memberships, etc are provided to employees to provide
them
It is something that incites or has a tendency to incite a determination. This is usually given in
cash or in kind.

Sangeetha K.K, Assistant Professor, Dept. of BBA, RJSIMS

 6th Semester BBA Compensation and Performance Management

In business, the objective of incentive is to increase employee productivity, improve industrial and
interpersonal relations, and as result increase the overall profit of the organization.

Incentive
Definition of Incentive
Incentive in simple terms is something that encourages a person or organization to do or achieve
something. It is something that incites or has a tendency to incite a determination. This is usually
given in cash or in kind.
In business, the objective of incentive is to increase employee productivity, improve industrial and
interpersonal relations, and as result increase the overall profit of the organization.

Types of Incentives
Incentives can be generally classified as financial (monetary) incentives and non-financial (non-
monetary) incentives.
1. Financial (Monetary) Incentives
Financial incentive pertains to those incentives which are in the form of money or can be measured
in monetary terms. This is sometimes referred to as monetary benefit offered to consumers,
employees, and organizations to encourage behavior or actions which otherwise would not take
place.
These incentives can be given on an individual or group basis and satisfy the monetary and future
security needs of individuals. It lifts the eagerness and self-confidence of the employees thus,
resulting in better productivity and performance.
The most commonly used financial incentives are:
Pay and allowance salary is the basic incentive given to every employee to work efficiently and
effectively in an organization. This includes the basic pay, dearness allowance, clothing
allowances, house rent allowances, and other similar allowances. It is paid most commonly
monthly.
Typically, employees are given annual increments in their basic pay and allowances depending on
the employee’s performance during the year.
 Bonus
It is a sum of money added to the basic salary or wages on a seasonal basis, as a reward for a good
performance. Many companies offer bonuses during the festivals of Diwali, Christmas, New Year,
etc.
 Productivity linked Wage Incentives
This refers to performance-linked compensation given to increase productivity. Wage incentives
are offered to employees to make them perform beyond the accepted standards.
For example, a manufacturing worker is paid 50 dollars per item if he produces 50 items a day but
if he produces more than 50 items a day, he is paid 5 dollars extra per item. Thus, on the 51st item,
he will receive 55 dollars.
 Profit-Sharing
It is an incentivized compensation program in which an employee receives a direct share of the
company’s profits. The amount granted is normally based on the company’s positive earnings over
a set period. This motivates them to perform efficiently and give their best to increase the
company’s profits.
 Retirement benefits

Sangeetha K.K, Assistant Professor, Dept. of BBA, RJSIMS

 6th Semester BBA Compensation and Performance Management

Retirement benefits like gratuity, pension, provident fund, leave encashment, etc. provide financial
security to the employees upon retiring from the company Hence, they work properly during their
term of service.
 Commission
Some companies offer a commission on top of the employee’s salary for successfully hitting
targets over a set period. This incentive motivates the employees to increase the client base of the
organization.
 Perquisites
Several organizations offer perquisites and fringe benefits such as free accommodation, medical,
educational, and recreational facilities, car allowances, etc. in addition to the salary and allowances
to their employees. Sometimes, this incidental payment, benefit, or privilege is enjoyed as a result
of one’s position.
 Co-partnership/Stock Option
Under this incentive system, employees are offered shares at a price that is lower than the market
price. This practice helps in creating a feeling of ownership among employees and motivates them
to give their all-out contribution towards organizational growth and success.
2. Non-Financial (Non-Monetary) Incentives
These are types of rewards that do not form part of an employee’s pay or cannot be measured in
terms of money.
While the monetary and future security needs are important, the fulfillment of an individual’s
social, psychological, and emotional needs also plays an important role.
 Status
It is one’s social or professional position. In an organization, this refers to the position in the
hierarchy of the organizational chart. Management-level employees have more authority,
responsibility, recognition, salary, etc., than those of the rank-and-file employees.
The level of authority and responsibility determine the status of an employee in an organization.
Status increases the self-esteem, confidence, and psychological needs of an individual resulting in
a motivated attitude at work.
 Organizational Climate
Organizational climate refers to the environmental characteristics of an organization as perceived
by its employees. It conveys the impression that people have towards the internal environment of
the company within which they work and have a key influence on their performance.
This differs from one organization to another. Several factors may influence the organizational
climate of a company, such as organizational structure, individual responsibility, risk and risk-
taking, warmth, and support within the company, its tolerance and conflict, and more. A positive
organizational climate tends to increase the efficiency of employees at work.
 Career Advancement Opportunity
Organizations have to establish the appropriate skill and career development programs, and even
a sound promotion policy for their employees, that serves as a booster for them to perform well
and get promoted. Upward progress in one’s career, such as promotion, shows recognition and
appreciation of an employee’s work, motivating him to do better.
 Job Enrichment
It refers to the designing of jobs in such a way that it involves challenging and variety of tasks,
requiring a higher level of knowledge and skill, more autonomy and responsibility, and more
growth opportunities and thus, could also increase employees’ pay. Sometimes, when the job itself
is interesting, it already serves as a good source of motivation.

Sangeetha K.K, Assistant Professor, Dept. of BBA, RJSIMS

 6th Semester BBA Compensation and Performance Management

 Job Security
Job security offers future stability and a sense of security among the employees in an organization.
Not having to worry about the future gives a sense of enthusiasm at work. While there is an
undesirable aspect of this incentive, like employees taking their jobs for granted, the increasing
rate of unemployment in our country makes this a great work incentive.
 Employee Recognition Programs
The organization adopts this to raise employee morale, attract and retain key employees, elevate
productivity within an organization, and increase competitiveness. This pertains to employers’
initiatives to reward their employees for achievements, new behaviors, anniversaries, and
milestones unlocked during their stay in the company.
For example, rewarding the best performer of the month, and announcing and displaying their
names on the notice boards, are programs for employee recognition.
 Employee Participation and Empowerment
This refers to the employee’s involvement in decision making on the matters related to them
(participation) inducing a sense of belongingness and giving them more autonomy and powers to
subordinates (empowerment) to make them feel the importance of their presence and service to
the organization.
In a 2009 survey conducted by McKinsey & Company, non-financial incentives were valued as
more influential motivators than financial incentives.
The top three financial rewards were performance-based cash bonuses, an increase in base pay,
and stock or stock options. The top three non-financial incentives were praise and commendation
from an immediate manager, attention from leaders, and opportunities to lead projects or task
forces.
 The most popular incentive – praise from the boss
 The second most popular – attention from leaders
 The least popular – stock or stock options
 All three of the non-financial incentives were more popular than the leading financial incentive

According to the survey, the top two incentives are based on getting praise and validation from
their immediate supervisors or management. These two elements are considered vital to all
dealings, including employee-employer. Commendation and validation should be the focus of non-
financial incentives for employees.
Effective Non-financial Incentives
An effective non-monetary incentive for employees directly touches emotions to make the
employee feel good, appreciated, and valued.
Investing in the workforce by showing appreciation and recognition in imaginative ways is one of
the best ways for companies to retain talented employees and create a sustainable culture of
success.

Characteristics of a Good Incentive Plan

The basics of a good incentive plan are:
a. Simple and easy to understand
b. Lessor is not costly to operate
c. Must be discussed with employees before implementation
d. Assist in supervision
e. Able to evaluate employee’s performance

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6th Semester BBA Compensation and Performance Management

f. Induce cooperation among the employees

g. Encourage workers to perform better
h. Acceptable to employee and employer
i. Ensure sufficient monetary compensation and recognition to employees
j. Ensure reduction in unit production cost
k. Standardized methods of implementation
l. Eliminate distrust between the employee and employer

Advantages of rewards and incentives in the workplace

A leadership team that incorporates rewards and incentives in the workplace can expect these
benefits:
 Increased productivity
Rewards and incentives help increase productivity in the workplace as every employee
works harder to meet their goal and secure a reward. Sometimes it's the reward that's largely
motivating, but most of the time, it's the recognition that comes with it that inspires an
employee to push themselves a little more.
 Loyal employees
It's important to employees that they feel their leadership team recognizes their work and
values what they do. Although employees can be happy receiving recognition without
reward, a motivating and thoughtful reward lets the employee know what they have made
a difference for their team and the organization. Staff members who feel appreciated and
know their hard work is not in vain usually become loyal to the company and even
recommend open positions to their contacts.
 A culture of friendly competition
You can develop incentive programs that are team-based or individual. Either way, it's a
way to introduce some friendly competition to the group. A strong team will love being
able to challenge each other while having the ability to receive rewards for their efforts.
Competition is motivating, and leaders may notice the hard work their team puts in to come
out on top.
 More accountability
With team-based rewards and incentives, where a whole team has to reach certain goals or
complete specific actions to get the reward, you can introduce a heightened sense of
accountability. Teammates hold each other accountable so they can succeed together, and
individuals hold themselves accountable so they don't let their team down. Accountability
in the workplace typically equates to fewer errors, which is a major benefit for businesses.
 Boosted morale
Getting recognized and receiving a reward or incentive that resonates with the staff boosts
morale. With the right culture in place, teammates should encourage each other to do well
so they can celebrate everyone's accomplishments. Employees feel the support of their
coworkers and leaders, which helps to boost team morale as everyone works toward the
same goal of helping the business succeed.
 Increased employee motivation
When employees have something to work toward and know that in the end, they'll receive
a reward or incentive that they can enjoy, it's a huge motivator. Most people are inherently
competitive in that they want to stand out from their peers so leadership considers them for
promotions, raises and more responsibility, and it's the same when receiving rewards.

Sangeetha K.K, Assistant Professor, Dept. of BBA, RJSIMS

6th Semester BBA Compensation and Performance Management

Employees become motivated to do well so they can experience the reward, but it also
motivates them to make their leaders and team proud.
 Improved collaboration
If a leader creates rewards and incentives for the entire team as they work together on a
project, or splits the group into multiple teams to tackle different facets of the task at hand,
teammates should improve their collaboration. Staff members are working toward a
common goal where each one has a responsibility to do their part to complete the project.
It requires that they celebrate each other's strengths, brainstorm together to figure out a
problem and work through differences of opinion to move forward.

Social Security
The concept of social security is based on ideas of human dignity and social justice.
The underlying idea behind social security measures is that a citizen who has contributed or
is likely to contribute to his/her country’s welfare should be given protection against certain
hazards.
The wages provided to the employees, particularly of the lower level may not be
sufficient to meet their needs like medical, children education, maternity needs of women
employees and employees’ wives’ etc. Therefore, Governments of various countries insist the
employers to provide the security to their employees against the social evils. In addition.
Governments also provide social security measures to the people.

Meaning and Definition

The term social security has been defined differently by authorities and, thus, there is no
commonly accepted definition of the term. There are mainly two streams of thought on this issue,
one represented by the ILO that limits the scope of social security to maintenance of one’s income
against loss or diminu-tion.
The ILO has defined social security as ‘the surety that society furnishes, through
appropriate organization, against certain risks to which the members are exposed. These risks
are essentially contingencies against which the individuals of small means and meagre
resources cannot effectively provide by their own ability or presight or even in private
combination with their fellow workers—these risks being sickness, maternity, invalidity, old
age, and death. It is the characteristics of these contingencies that they imperil the ability of
the working class to support itself and its dependent in health and decency’.
According to Lexicon Universal Encyclopaedia, the term social security has been defined as
‘consisting of public programmes intended to protect workers and their families from income
losses associated with the old age, illness, unemployment, or death. The term sometimes is
also used to include a broad system of support for all those who, for whatever reasons, are
unable to maintain themselves’.

Social Security – 4 Main Characteristics of Social Security Program

The main characteristics of the social security program are as follows:
(1) Social Security Schemes are providing social assistance and social insurance to employees
who have to face challenges of life without regular earning due to some contingencies in their
life.
(2) These Schemes are implemented by enactments of law of the country.

Sangeetha K.K, Assistant Professor, Dept. of BBA, RJSIMS

6th Semester BBA Compensation and Performance Management

(3) They generally are relief providers to employees who are exposed to the risks of economic
and social security. This protection is provided to them by members of the society of which
he is a part.
(4) These Schemes have a broad perspective. They not only provide immediate relief to the
employees who have suffered on account of contingencies, but also provide psychological
security to others who may face the same problems in times to come.

Social Security – Importance for the Employees as well as the Society

Social security is basically related to the high ideals of human dignity and social
justice.
The importance of social security for the employee as well as the society is incredibly
high:
(a) Social Security is the main instrument of bringing about social and economic justice and
equality in the society.
(b) Social Security is aimed at protecting employees in the event of contingencies. This
support makes the employees feel psychologically secured. This enhances their ability to
work.
(c) Money spent on social security is the best investment which yields good harvest. The
workforce maintenance is very essential not only for the organization but also for the country
at large.
(d) In a welfare state, social security is an important part of public policy. In cou ntries where
social security is not given adequate consideration in public policy, the government remains
unsuccessful in maintaining equality and justice.

Social Security – Measures

Ensuring social security measures for the citizens of a country is the fundamental
responsibility of the government. India being a welfare state, the Constitution of India has
described it as a democratic and socialist Republic.
The clauses that define fundamental rights and formulate the directive principles of State
policy in our Constitution leave no doubt about the concern and commitment of the
government to the rights of citizens to enjoy social security. Ours is a democratic country
based on the premise of equality and accountability.
We are also a socialist state which accepts the responsibility for providing and ensuring
Social Security to all its citizens without any discrimination. Broadly speaking, the idea of
Social Security is that, the Centre and the State government shall make itself responsible for
ensuring a minimum standard of material welfare to all its citizens on a basis wide enough to
cover all contingencies of life.
There is perhaps no country in the world which does not take care of the Social
Security measures. But the types of Social Security measures provided by the various
governments differ from country to country.

Social Security – Benefits in India: Social Insurance and Social Assistance

India is a Welfare State as envisaged in her constitution. Article 41 of the Indian
Constitution lays down, “The State shall within the limits of its economic capacity and
development make effective provision securing the right to work, to education and to public

Sangeetha K.K, Assistant Professor, Dept. of BBA, RJSIMS

6th Semester BBA Compensation and Performance Management

assistance in case of unemployment, old age, sickness, and disablement and other cases of
unserved wants.”
Thus, social security constitutes an important step towards the goal of Welfare State,
by improving living and working conditions and affording people protection against the
various kinds of hazards.
Social security benefits are provided in India through legislations. Workmen’s
Compensation Act, 1923 enforces the employer to provide compensation to a workman for
any personal injury caused by an accident, for loss of earnings etc. The Employees’ State
Insurance Act, 1948 enforces the employers to provide sickness benefits, maternity benefit to
women employees, disablement benefit, dependent’s benefit, funeral benefit and medical
benefits.
The Employees Provident Fund and Miscellaneous Provisions Act, 1952 enforces the
employer to provide provident fund, deposit-linked insurance etc. The Maternity Benefit Act,
1961 provides for medical benefits, maternity leave etc. The Payment of Gratuity Act, 1952
provides for the payment of gratuity at the time of retirement.
Social security legislations in India suffer from the defects like duplication. For example.
Employees’ State Insurance Act and Maternity Benefit Act provide for maternity benefits. In
addition, different administrative authorities implement the law, resulting from overlapping.
Hence, the Study Group (1957-58) appointed by the Government of India suggested an
integrated social security scheme in India.
This integrated social security scheme should provide for medical care, insurance
against sickness, maternity benefits unemployment insurance, employment injury, and old
age pension. This scheme should be enforced by a single agency in order to avoid overlapping
and duplication.
India is a welfare state and social security is an essential component of government
policy.

Social security benefits in India are provided in two major way:

1. Social Insurance.
2. Social Assistance.
1. Social Insurance: In this scheme, a common fund is established with periodical
contributions from workers, according to their nominal paying capacity. The employers and
state provide the portion of the finance. Provident fund and group insurance are example of
this type.
2. Social Assistance: Under this, the cost of benefits provided is financed fully by the
government without any contributions from workers and employers. Howev er, benefits are
paid after judging the financial position of the beneficiary. Old age pension is an example.

Retirement Planning
Creating a retirement plan begins with determining your long-term financial goals and tolerance
for risk, and then starting to take action to reach those goals. The process can begin any time
during your working years, but the earlier the better.
The process of creating a retirement plan includes identifying your income sources, adding up
your expenses, putting a savings plan into effect, and managing your assets. By estimating your
future cash flows, you can judge whether your retirement income goal is realistic.

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6th Semester BBA Compensation and Performance Management

A key part of a retirement plan is taking advantage of one of the government-approved investment
vehicles, such as an individual retirement account (IRAs) or a 401(k) account, which offer tax
advantages to retirement savers. Your retirement plan needs to take into account your estimated
future expenses, liabilities, and life expectancy.

What Is a Retirement Plan?

A retirement plan may be seen as a roadmap to a comfortable life after work. It entails
accumulating enough money to pay for the lifestyle you want to enjoy in the future. Your
retirement plan may well change over time, but the earlier you get started the better.
A retirement plan is a strategy for long-term saving, investing, and finally withdrawing
money you accumulate to achieve a financially comfortable retirement.

Steps for planning your retirement:

1. Understand Your Time Horizon
Your current age and expected retirement age create the initial groundwork for
an effective retirement strategy. The longer the time from today to retirement, the higher the level
of risk that your portfolio can withstand. If you’re young and have 30-plus years until retirement,
you can have the majority of your assets in riskier investments, such as stocks. There will be
volatility, but stocks have historically outperformed other securities, such as bonds, over long
time periods. The main word here is “long,” meaning at least more than 10 years.
Additionally, you need returns that outpace inflation so you can maintain your purchasing
power during retirement.
In general, the older you are, the more your portfolio should be focused on income and
the preservation of capital. This means a higher allocation in less risky securities, such as bonds,
that won’t give you the returns of stocks but will be less volatile and provide income that you can
use to live on. You will also have less concern about inflation. A 64-year-old who is planning on
retiring next year does not have the same issues about a rise in the cost of living as a much younger
professional who has just entered the workforce.
You should break up your retirement plan into multiple components. Let’s say a parent
wants to retire in two years, pay for a child’s education at age 18, and move to Florida. From the
perspective of forming a retirement plan, the investment strategy would be broken up into three
periods: two years until retirement (contributions are still made into the plan), saving and paying
for college, and living in Florida (regular withdrawals to cover living expenses).
A multistage retirement plan must integrate various time horizons, along with the
corresponding liquidity needs, to determine the optimal allocation strategy. You should also
be rebalancing your portfolio over time as your time horizon changes.
2. Determine Retirement Spending Needs
Having realistic expectations about post-retirement spending habits will help you define
the required size of a retirement portfolio. Most people believe that after retirement, their annual
spending will amount to only 70% to 80% of what they spent previously.1
Such an assumption is often proven unrealistic, especially if the mortgage has not been paid off
or if unforeseen medical expenses occur. Retired adults also sometimes spend their first years
splurging on travel or other bucket-list goals.
As, by definition, retired adults are no longer at work for eight or more hours a day, they
have more time to travel, go sightseeing, shop, and engage in other expensive activities. Accurate

Sangeetha K.K, Assistant Professor, Dept. of BBA, RJSIMS

6th Semester BBA Compensation and Performance Management

retirement spending goals help in the planning process as more spending in the future requires
additional savings today.
Your longevity also needs to be considered when planning for retirement, so you don’t
outlast your savings. The average life span of individuals is increasing.
Additionally, you might need more money than you think if you want to purchase a home or fund
your children’s education post-retirement. Those outlays have to be factored into the overall
retirement plan. Remember to update your plan once a year to make sure that you are keeping on
track with your savings.
3. Calculate After-Tax Rate of Investment Returns
Once the expected time horizons and spending requirements are determined, the after-tax
real rate of return must be calculated to assess the feasibility of the portfolio producing the needed
income. A required rate of return in excess of 10% (before taxes) is normally an unrealistic
expectation, even for long-term investing. As you age, this return threshold goes down, as low-
risk retirement portfolios are largely composed of low-yielding fixed-income securities.
Depending on the type of retirement account that you hold, investment returns are
typically taxed. Therefore, the actual rate of return must be calculated on an after-tax basis.
However, determining your tax status when you begin to withdraw funds is a crucial component
of the retirement planning process.
4. Assess Risk Tolerance vs. Investment Goals
Whether it’s you or a professional money manager who is in charge of the investment
decisions, a proper portfolio allocation that balances the concerns of risk aversion and returns
objectives is arguably the most important step in retirement planning. How much risk are you
willing to take to meet your objectives? Should some income be set aside in risk-free Treasury
bonds for required expenditures? You need to make sure that you are comfortable with the risks
being taken in your portfolio and know what is necessary and what is a luxury.
5. Stay on Top of Estate Planning
Estate planning is another key step in a well-rounded retirement plan, and each aspect
requires the expertise of different professionals, such as lawyers and accountants, in that specific
field. Life insurance is also an important part of an estate plan and the retirement planning process.
Having both a proper estate plan and life insurance coverage ensures that your assets are
distributed in a manner of your choosing and that your loved ones will not experience financial
hardship following your death. A carefully outlined plan also aids in avoiding an expensive and
often lengthy probate process.
Tax planning is another crucial part of the estate planning process. If an individual wishes
to leave assets to family members or a charity, the tax implications of either gifting or passing
them through the estate process must be compared.
A common retirement plan investment approach is based on producing returns that meet
yearly inflation-adjusted living expenses while preserving the value of the portfolio. The portfolio
is then transferred to the beneficiaries of the deceased. You should consult a tax advisor to
determine the correct plan for the individual.

Pension Plans
Pension or retirement plans offer the dual benefit of investment and insurance cover. By
investing a certain amount regularly towards your pension plan, you will accumulate a
considerable sum in a phase-by-phase manner. This will ensure a steady flow of funds once you
retire.

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Public Provident Fund is one of the most popular retirement planning schemes in India.
When you start contributing to your retirement early, the funds build a secure golden year money-
wise over the years.

Who should opt for Pension Plans?

Every individual should invest in pension plans to secure their retired life financially. Section 80C
of the Income Tax Act, 1961, covers several retirement plans and taxpayers are eligible for tax
deductions of up to Rs.1.5 lakh. Any plan you choose must be in sync with your investment goals
(or retirement plans). For example, if you wish to retire early, then your corpus upon maturity
should be enough to support your retired life. Hence, the key is to choose the retirement plan
smartly.

Features & Benefits of Pension Plans

1. Guaranteed Pension/Income
You can get a fixed and steady income after retiring (deferred plan) or immediately after
investing (immediate plan), based on how you invest. This ensures a financially
independent life after retiring. You can use a retirement calculator to have a rough estimate
of how much you might require after retiring.
2. Tax-Efficiency
Some pension plans provide tax exemption specified under Section 80C. If you wish to
invest in a pension plan, then the Income Tax Act, 1961, offers significant tax respite under
Chapter VI-A. Section 80C, 80CCC and 80CCD specify them in detail. For instance, Atal
Pension Yojana (APY) and National Pension Scheme (NPS) are subject to tax deductions
under Section 80CCD.
3. Liquidity
Retirement plans are essentially a product of low liquidity. However, some plans allow
withdrawal even during the accumulation stage. This will ensure funds to fall back on
during emergencies without having to rely on bank loans or others for financial
requirements.
4. Vesting Age
This is the age when you begin to receive the monthly pension. For instance, most pension
plans keep their minimum vesting age at 45 years or 50 years. It is flexible up to the age of
70 years, though some companies allow the vesting age to be up to 90 years.
5. Accumulation Duration
An investor can either choose to pay the premium in periodic intervals or at once as a lump
sum investment. The wealth will simultaneously accumulate over time to build up a sizable
corpus (investment+gains). For instance, if you start investing at the age of 30 and
continues investing until you turn 60, the accumulation period will be 30 years. Your
pension for the chosen period primarily comes from this corpus.
6. Payment Period
Investors often confuse this with the accumulation period. This is the period in which you
receive the pension post-retirement. For example, if one receives a pension from the age of
60 years to 75 years, then the payment period will be 15 years. Most plans keep this
separate from accumulation period, though some plans allow partial/full withdrawals
during accumulation periods too.
7. Surrender value

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Surrendering one’s pension plan before maturity is not a smart move even after paying the
required minimum premium. This results in the investor losing every benefit of the plan,
including the assured sum and life insurance cover.

Profit Sharing Plan

A profit sharing plan is a type of employee benefit plan in which a company shares a
portion of its profits with its employees. This shared profit is typically distributed among
employees based on a predetermined formula or criteria defined by the company. Profit-sharing
plans serve as a financial incentive for employees, motivating them to contribute to the company's
success.

What is profit sharing?

Profit sharing is a compensation system or incentive program in which a company shares
a portion of its profits with its employees. Under profit sharing, employees receive a bonus or
additional payment based on the company's financial performance and profitability. This
additional payment is typically in addition to their regular wages or salaries.

The key characteristics and aspects of profit sharing:

1. Distribution of profits: Profit sharing involves the distribution of a portion of the
company's profits among its employees. The amount distributed is determined by a
predetermined formula or criteria established by the company.
2. Motivation and incentive: The primary purpose of profit sharing is to motivate employees
to work diligently and contribute to the company's success. By giving employees a direct
financial stake in the company's profitability, it encourages them to be more productive
and aligned with the organization's goals.
3. Variable payments: Profit sharing payments are variable and can vary from year to year.
In profitable years, employees may receive more substantial profit-sharing bonuses, while
in less profitable years, the payouts may be smaller or nonexistent.
4. Additional compensation: Profit sharing payments are in addition to an employee's
regular salary or wages. They provide an extra financial reward for employees based on
the company's performance.
5.
What are different types of profit sharing plans?
There are several different types of profit-sharing plans that companies can implement to
distribute a portion of their profits to employees. Each type of profit-sharing plan has its own
characteristics and objectives.
Here are some of the most common types:
1. Cash profit-sharing plan: In a cash profit-sharing plan, employees receive their share of
the company's profits in the form of cash bonuses. These bonuses are typically added to
employees' paychecks and are subject to income tax. Cash profit-sharing plans provide
immediate financial rewards to employees.
2. Deferred profit-sharing plan (DPSP): A deferred profit-sharing plan is designed to
encourage long-term savings and retirement planning. Instead of receiving cash bonuses,
employees' profit-sharing contributions are deferred and invested on their behalf.

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Employees typically access these funds upon retirement, disability, or other predetermined
events.
3. Stock-based profit-sharing plan: Some companies offer profit-sharing plans in which
employees receive company stock or stock options as part of their profit-sharing rewards.
This type of plan aligns employee interests with the company's performance and can make
employees feel like partial owners of the company.
4. Combination plan: A combination profit-sharing plan combines elements of both cash
and deferred contributions. In these plans, a portion of the profit-sharing rewards is
distributed as cash bonuses, while another portion is deferred into a retirement account or
other savings vehicle. This approach provides employees with both immediate and long-
term benefits.
5. Percentage of profits plan: Under this type of plan, a fixed percentage of the company's
profits is allocated to the profit-sharing pool. The total amount distributed to employees
can vary based on the company's financial performance. The percentage of profits plan
does not rely on individual employee factors like salary or job position.
6. Age-weighted profit-sharing plan: Age-weighted profit-sharing plans take into account
the age of employees as a factor in determining profit-sharing allocations. Older employees
typically receive larger contributions, as they have fewer years until retirement and less
time to accumulate retirement savings.
7. New comparability profit-sharing plan: New comparability plans allow employers to
allocate profit-sharing contributions disproportionately among employees based on factors
such as job classification or other criteria. This approach can be used to reward specific
groups of employees, such as executives or key personnel.
8. Integrated profit-sharing plan: Integrated profit-sharing plans are designed to work in
conjunction with Social Security benefits. The profit-sharing contributions are integrated
with Social Security to provide higher benefits for employees with lower Social Security
benefits.
9. Cross-tested profit-sharing plan: Cross-tested plans are often used by businesses with
both highly compensated and non-highly compensated employees. These plans allocate
contributions based on age, service, or other criteria to ensure that they meet IRS
nondiscrimination requirements.
10. Performance-based profit-sharing plan: In this type of plan, profit-sharing contributions
are tied to specific performance metrics or financial targets. Employees who meet or
exceed these performance goals receive larger profit-sharing rewards.

What are benefits of profit sharing plan?

1. Financial reward: Employees receive a portion of the company's profits as an additional
source of income. This can significantly boost their overall compensation and financial
well-being.
2. Motivation: Profit-sharing plans motivate employees to work harder, be more productive,
and make decisions that contribute to the company's profitability. When employees see a
direct financial benefit tied to company performance, they are often more motivated to
perform at their best.
3. Ownership mentality: Profit-sharing fosters a sense of ownership among employees.
They feel a greater connection to the company's success and may take more pride in their
work and contributions.

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4. Long-term savings: Deferred profit-sharing plans (DPSPs) encourage employees to save

for retirement or other long-term financial goals. These plans help employees build
financial security for the future.
5. Retention: Companies that offer profit-sharing plans may experience improved employee
retention. Employees who receive profit-sharing rewards are often more loyal to the
company and less likely to seek employment elsewhere.
6. Positive workplace relations: Profit sharing can lead to better relations between
employees and management. Employees may feel valued and recognized for their
contributions, contributing to a positive work environment.

What are examples of profit sharing plan?

The examples of profit sharing are:
1. Southwest Airlines: Southwest Airlines is known for its profit-sharing program, which is
one of the most generous in the airline industry. Employees receive a percentage of the
company's annual profits as part of their compensation. The program has contributed to the
company's positive corporate culture and employee satisfaction.
2. Publix Super Markets: Publix, a supermarket chain, has a successful profit-sharing plan
for its employees. The plan, known as the Publix Stockholder program, allows eligible
employees to become company shareholders over time. This ownership stake is funded
through profit-sharing contributions and helps create a sense of ownership among
employees.
3. American Fidelity Assurance Company: This insurance and financial services company
has a robust profit-sharing program that rewards employees based on company
performance. The program includes both cash bonuses and contributions to employees'
retirement accounts.
4. Lincoln Electric: Lincoln Electric, a manufacturer of welding equipment and supplies, has
a unique profit-sharing program known as the "Incentive Management Program."
Employees receive bonuses based on achieving certain performance targets, and the
program has been a key factor in the company's success and low turnover rates.

What are limitations of profit sharing plan?

1. Dependence on company profits: Profit-sharing plans are directly tied to the financial
performance of the company. When the company experiences a downturn or lower profits,
profit-sharing payouts may be reduced or eliminated altogether. This can lead to
disappointment and frustration among employees who were expecting additional income.
2. Lack of predictability: Employees may find it difficult to predict their profit-sharing
bonuses accurately. The variable nature of these payments can make financial planning and
budgeting more challenging for employees.
3. Concentration of risk: Employees' retirement savings may become concentrated in the
performance of the company's stock if the profit-sharing plan includes stock-based
rewards. This concentration can pose risks, especially if the company's stock performs
poorly.
4. Inequity among employees: Depending on the design of the profit-sharing plan, some
employees may receive significantly larger bonuses than others, leading to perceptions of
inequity within the organization. This can potentially harm morale and teamwork.

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5. Administrative complexity: Establishing and managing a profit-sharing plan can be

administratively complex and costly for employers. Compliance with tax and regulatory
requirements, record-keeping, and communication with employees require careful
attention.
6. Lack of employee control: Employees have no control over the company's financial
performance, which directly impacts their profit-sharing rewards. This lack of control can
be frustrating for employees who may feel that their efforts alone do not determine their
bonuses.

Stock Bonus Plan

A stock bonus plan is a type of profit-sharing plan that rewards employees with company stock
rather than cash. These plans are designed to align the interests of employees with those of
shareholders, motivate long-term commitment to the company, and offer tax benefits to the
employer and potentially the employees.

Here’s a brief overview of how stock bonus plans work:

 Contribution: The company contributes shares of its stock or cash to purchase its stock
on behalf of eligible employees. The amount of the contribution can be discretionary and
may be based on the company’s profitability, individual employee performance, or other
predetermined criteria.
 Allocation: The stock or equivalent value is allocated to individual employee accounts
within the plan. Allocation can be based on factors like salary, years of service, or a
combination of both.
 Vesting: Like other retirement plans, stock bonus plans often include vesting schedules.
Vesting schedules determine when the stock in an employee’s account is truly “owned” by
the employee. If an employee leaves the company before they are fully vested, they may
forfeit some or all of the stock in their account.
 Distributions: Employees typically receive the stock in their account when they retire or
leave the company. Depending on the plan, they might receive actual shares of stock or the
cash equivalent of the stock’s value.
 Tax Implications:
 For employers: Contributions to a stock bonus plan are usually tax-deductible when
made, similar to other retirement plan contributions.
 For employees: Employees generally don’t pay taxes on contributions when they’re
made. Instead, they pay taxes upon distribution, similar to withdrawals from a
traditional 401(k) plan. If the distribution is in the form of stock, the employee would
typically pay taxes on the value of the stock when received. Any subsequent
appreciation in stock value would be subject to capital gains tax when the stock is sold.

What Is Equity-Based Compensation?

In equity-based compensation, a contract is established between the company and the employee,
giving the employees the right to purchase company shares at a fixed price upon satisfying certain
pre-established conditions. These conditions can vary from working at the company for a certain
time frame to achieving specific milestones.
There are several models that companies can choose from when establishing their equity-based
compensation framework. The benefits of offering equity-based compensation for employees

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include the opportunity for monetary gains as well as a greater stake in the business. Additionally,
startups can retain their employees for a longer period and accelerate the achievement of business
goals.

Key Terminology
Here’s a snapshot of common terminology used to describe the various equity-based compensation
models:
1. ESOP – The Employee Stock Option Plan that enables employees to purchase the company stock
and become shareholders in the business.
2. Vesting – The process by which the employee earns the option to purchase the stock.
3. Vesting Period – The time frame during which the employee needs to fulfill pre-determined
conditions to be eligible to enjoy the benefits of their equity-based compensation plan.
4. Exercise – The process of purchasing the shares once the stock is vested.
5. Exercise period – The time frame during which the employee must exercise the stock option after
the vesting period is over.
6. Exercise Price – The price at which an employee purchases a share.
7. Grant/strike price – The predetermined price at which the employee can buy company shares when
exercising the stock options.

Types of Equity-Based Compensation

Equity-based compensation is not a one-size-fits-all. There are several options, and companies
must choose the right fit to reap substantial benefits.
Stock Options
This is one of the most basic types of equity-based compensation. Essentially, companies offer
employees (or potential employees) the right to buy shares of the company’s stock at a
predetermined price, which is typically lower than the market price.
Once the option vests, the employee can exercise the option. Stock options have emerged as a key
strategy to attract fresh hires and retain existing employees. There are two types of stock options.
1. Incentive stock options (ISOs)
The ISOs are stock options that come with tax benefits and are often given to highly valued
employees. The recipient of ISOs has the opportunity to purchase shares at a much lower exercise
price than the market price, thus creating a potential for significant monetary benefit.
Within one year of exercising them, the profits will be taxed as ordinary income. However, if they
are sold after one year, the profits are taxed as capital gains.

2. Non-qualified stock options (NSOs)

The NSOs, unlike ISOs, do not come with tax privileges. When the employees exercise these
shares, they need to pay taxes on the difference between the grant price and the exercise price.
This amount is taxed as ordinary income or a combination of ordinary income and capital gains.
Hence, NSOs are a much more commonly awarded stock option than ISO.
Restricted Stock
When offering restricted stock, a company promises to offer shares to an employee after certain
conditions are met. Within this category, Restricted Stock Units (RSUs) are awarded by the
company typically to high-level executives after being at the company for a certain amount of
time; they do not need to be purchased.

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On the other hand, Restricted Stock Awards (RSAs) are offered to employees placed lower in the
hierarchy upon satisfying certain conditions. If the conditions are not met, RSAs can be forfeited.
Performance Shares
This is a type of contract where stock options are granted to managers and executives based on
their ability to achieve certain performance-related goals.
The performance is usually tied to their ability to increase return on investment and create more
value for shareholders. These shares are awarded as payment for achieving these critical
milestones that accelerate a company’s success trajectory.

Employee Stock Ownership Plan (ESOP)

What is an Employee Stock Ownership Plan (ESOP)?

An employee stock ownership plan (ESOP) is an employee benefit plan that gives workers
ownership interest in the company in the form of shares of stock. ESOPs give the sponsoring
company—the selling shareholder—and participants various tax benefits, making them qualified
plans, and are often used by employers as a corporate finance strategy to align the interests of their
employees with those of their shareholders.

KEY TAKEAWAYS
 An employee stock ownership plan (ESOP) is an employee benefit plan that gives workers
ownership interest in the company in the form of shares of stock.
 ESOPs encourage employees to give their all as the company’s success translates into
financial rewards.
 They also help staff to feel more appreciated and better compensated for the work they
do.
 Companies typically tie distributions from the plan to vesting, which gives employees
rights to employer-provided assets over time.
 It’s important to read the terms of your ESOP, as each one may vary and have different
rules.
 Other versions of employee ownership include direct-purchase programs, stock options,
restricted stock, phantom stock, and stock appreciation rights.

How Does an Employee Stock Ownership Plan (ESOP) Work?

An ESOP is usually formed to facilitate succession planning in a closely held company by allowing
employees the opportunity to buy shares of the corporate stock. ESOPs are also offered as a
retirement benefit.

ESOPs are set up as trust funds and can be funded by companies putting newly issued shares into
them, putting cash in to buy existing company shares, or borrowing money through the entity to
buy company shares. ESOPs are used by companies of all sizes, including a number of large
publicly traded corporations.

Contrary to what some people say, companies with an ESOP must not discriminate and are
required to appoint a trustee to act as the plan fiduciary. Among other things, it is not possible for
senior employees to receive more shares or for ESOP participants to have no voting rights.

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Although, to be clear, senior employees will naturally accumulate and have more vested shares
over time.

Advantages of ESOPs
Since ESOP shares are part of the employees’ remuneration package, companies can use ESOPs
to keep plan participants focused on corporate performance and share price appreciation. By giving
plan participants an interest in seeing the company’s stock perform well, these plans supposedly
encourage participants to do what’s best for shareholders, since the participants themselves are
shareholders.
Employees, meanwhile, are presented with a way to make more money, increase their
compensation, and essentially be rewarded for their hard work and commitment. Having a stake
in the company should make employees feel more appreciated and perhaps make going to work
more exciting.

How to Cash Out of an ESOP

Being vested doesn’t necessarily mean you can cash out of your ESOP. Generally, it’s only
possible to redeem these shares if you terminate employment, retire, die, or become disabled.
Age is often an important factor. Distributions are rarely permitted to people under 59½, or 55 if
they have left the company. If there are distributions before these ages, they would normally be
subject to a 10% tax penalty
ESOPs, or Employee Stock Ownership Plans, are designed to incentivise employees and create a
sense of ownership and commitment within the company. This arrangement is mutually beneficial,
allowing employees to participate in the company’s success and reap the rewards of their hard
work. It also provides companies with a tax-efficient way to distribute ownership and engage
employees. In this post, we will discuss the concept in detail, as well as its purpose, benefits, and
how it works.

What Is ESOP?
An ESOP is an employee benefit plan that allows employees to become company shareholders. It
fosters a sense of ownership and alignment with the company’s success. Under this plan,
employees are granted shares of company stock, either through direct purchase or as part of their
compensation package.
The purpose of an employee stock ownership plan in the corporate structure is twofold. Firstly, it
provides employees with a financial stake in the company’s performance, giving them a vested
interest in its success. This can motivate employees to work harder and contribute to the company’s
growth and profitability.
Secondly, it can be a valuable tool for succession planning and business continuity. As older
owners and executives retire, the ESOP can gradually buy their shares, allowing the company to
remain in the control of its employees.
How Does An Employee Stock Ownership Plan Work?
An ESOP operates through a step-by-step process that begins with allocating company stock to
eligible employees. This can be done through various methods such as direct purchases,
contributions from the company, or as part of an employee’s compensation package. Once the
stock is allocated, it is subject to a vesting period, a predetermined time frame during which the
employee must remain with the company to fully own the shares.

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During the vesting period, employees gradually gain ownership rights to their allocated shares
based on a predetermined schedule. This schedule can be based on years of service or other
performance criteria determined by the company. Once the vesting period is complete, employees
can exercise their ownership rights by purchasing the allocated shares at a predetermined price,
often at a discount to the market value.
The exercise of options by employees allows them to become full-fledged shareholders and enjoy
the benefits of ownership, including voting rights and potential financial gains if the company’s
stock value increases. Notably, these plans typically have rules and regulations to prevent the
premature sale or transfer of shares, ensuring employees’ long-term commitment and alignment
with the company’s goals.
ESOP Initial Costs
The setup and administrative costs of initiating an ESOP can vary depending on several factors.
Companies considering this plan should carefully assess these costs to determine if they align with
their financial capabilities and long-term goals.
Some initial costs include legal and consulting fees for drafting the employee stock ownership plan
document, obtaining necessary regulatory approvals, and ensuring compliance with all applicable
laws and regulations. Additionally, companies may need to hire an independent trustee to oversee
and provide fiduciary guidance. Ongoing administrative costs may include:
Record-keeping.
Annual valuations of company stock.
Employee communication and education about the ESOP.
Companies must consider these costs alongside the potential benefits of an ESOP, such as
enhanced employee engagement, tax advantages, and succession planning. Careful evaluation and
thorough financial analysis will help companies implement an employee stock ownership plan that
aligns with their strategic objectives and financial resources.
Benefits Of ESOP For The Employer
ESOPs, or Employee Stock Ownership Plans, offer a range of benefits for both employers and
employees. One significant advantage is the increased employee loyalty resulting from company
ownership. When employees have a stake in the organisation’s success, they are more motivated
to contribute their best efforts and take pride in their work. This can lead to higher productivity
and overall company performance.
From a tax perspective, it can provide significant advantages. Contributions made are tax-
deductible for the employer, helping to reduce their tax liability. For employees, the stock received
through such plans is not taxed until it is sold, allowing for potential tax savings.
Furthermore, studies have shown that companies with employee stock ownership plans tend to
outperform their counterparts. By involving employees in ownership, it creates a culture of shared
responsibility and collaboration, fostering a sense of commitment among workers. This can result
in improved company performance, innovation, and competitiveness in the market.

Tax Implication Of ESOP

In India, the tax treatment of ESOPs plays a crucial role in determining the financial implications
for employees. Employees are not subject to any tax liability when exercising the options and
acquiring shares. Taxation occurs when the employees sell these shares.
The profit or gain from selling these shares is categorised as capital gains. The taxability of these
gains depends on the holding period of the shares. If the shares are held for less than 24 months,

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they are considered short-term capital assets, and the gains are subject to short-term capital gains
tax, calculated at the individual’s applicable income tax slab rate.
On the other hand, if the shares are held for more than 24 months, they are classified as long-term
capital assets. In such cases, the gains are subject to long-term capital gains tax, currently levied
at a concessional rate of 20% with indexation benefits.
Employees need to understand the specific tax implications and consult with a tax professional to
ensure compliance with the tax laws and optimise their tax position. Proper tax planning and
awareness of these tax treatments can help individuals make informed decisions regarding
exercising and selling these shares.

Compensation Management
What is compensation management?
It is managing and determining an employer’s compensation to the employees in return for their
work.
Compensation management involves managing, analysing, and determining the salary, benefits,
and incentives paid to the employees. Compensation management plays a crucial role in attracting
and retaining top talent. It includes monetary as well as non-monetary benefits. It also increases
employee productivity and reduces employee turnover.
Additionally, it ensures that every employee gets paid a fair wage based on industry standards,
work experience, company budget, etc.
Key factors affecting compensation management
 Productivity of workers– Productivity-based compensation helps derive the best results.
The higher the productivity of employees, the more should be the compensation.
 Ability to pay– If your company has high profitability, you can pay better compensation
and retain your employees and vice versa.
 Government Policies– Government also has certain policies to protect employee interests.
The employer has to pay the employees as per governmental regulations and provide benefits
such as PF, medical insurance, gratuity, and pension.
 Labour Unions– They also play an essential role in ensuring employees get a fair wage.
They fight with the employers for the employee’s rights and wage revision.
 Cost of Living– Cost of living also influences compensation to a large extent. An employee
based in a city with a high cost of living needs a higher salary and vice versa.
 Demand and Supply of Labour– It is one of the most important factors that affect the
compensation of employees. If the demand is more than the supply, the compensation will
be higher.
 Industry Standards– No employee would like to join a company whose compensation is
below the industry standards. Therefore you need to analyse the standard market rates of
different roles and pay your employees accordingly.

Different types of compensation

The types of compensation are broadly classified into direct compensation and indirect
compensation. Let us look at them in detail.
Direct Compensation
It is the monetary benefits provided by the employer to the employees.
 Hourly pay– Hourly pay is the salary paid for each hour of work that the employee does.
 Salary– Salary is the fixed monthly amount that the employer pays to the employee in cash.

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 Commission– A monetary reward that is paid based on the performance of an individual. It

is generally provided in the case of sales jobs as a fixed percentage.
 Bonus– A bonus is a monetary incentive paid to employees for their good performance. It is
paid over and above the employee’s basic salary.

Indirect Compensation
Indirect compensation refers to non-monetary benefits like paid holidays, insurance, and
retirement benefits.
 Insurance– Employers generally provide employees with medical insurance to ensure good
health of their employees. If you are an early-stage startup facing difficulties getting
employee insurance, check out RazorpayX Payroll. It provides group insurance packages to
teams as small as 2!
 Paid holidays– Paid holidays are provided to help employees maintain a work-life balance.
 ESOPs– Sometimes, companies also provide their employees with their shares at a
discounted price, offering them an additional opportunity to earn.
 Retirement Benefits– Retirement benefits include gratuity, pension, general provident
fund, leave encashment, etc.
 Leave travel allowance– LTA or leave travel allowance is the non-monetary benefit
provided by the employer to the employee where the employer covers the employee’s
travel expenses.
 Relocation expenses– Relocation expenses are the benefits the employer provides in case
the job requires relocation to a different city.

Importance of compensation management for HR Leaders

While the list of reasons why you should focus on compensation management is rather long, here
are a few main reasons-
 Helps Plan Your Budget– Employee salaries are the highest cost for any startup.
Compensation management helps determine the costs beforehand and plan the budget
accordingly. It also helps plan increments and other benefits based on industry standards.
 Helps Motivate Employees- Compensation is the key factor influencing an employee’s
productivity. A well-paid employee is more likely to work hard for your company and vice
versa.
 Reduces Employee Turnover– Giving adequate monetary and non-monetary benefits helps
increase job satisfaction and reduce the rate of employee turnover.
 Attracts Best Talent– It not only prevents employees from switching jobs but also helps
attract top talent. The best talent always looks for a company with a competitive salary and
benefits like insurance, paid time off, leave allowance, flexible benefits, etc.

How is compensation management determined?

In India, compensation determination involves a combination of factors, including market
practices, legal regulations, industry standards, and individual performance:
 Job role and responsibilities
 Industry and market trends
 Geographical location
 Company size and financial health
 Experience and expertise

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6th Semester BBA Compensation and Performance Management

 Education and qualifications

 Performance and contributions
 Legal and regulatory factors (mentioned in the above sections)
 Gender equality and non-discrimination
 Collective bargaining and industry standards
 Benefits and perks
 Inflation and economic conditions

Key Elements of Compensation Management

Effective compensation management involves several key elements. These include:

Job Analysis:
The first step in compensation management is to conduct a job analysis. This involves evaluating
each job in the organization to determine its value and importance to the company.

Job Evaluation:
Identically, once job analysis is complete, the next step is job evaluation. This involves assessing
the relative worth of each job in the organization and assigning it a monetary value.

Salary Surveys:
Salary surveys are used to determine the compensation offered by other organizations in the same
industry and geographic region for similar jobs. This helps ensure that the organization's
compensation package is competitive.

Salary Structure:
The salary structure is the framework that determines the compensation package for employees. It
includes the base pay, bonuses, benefits, and any other forms of compensation.

Performance Management:
Performance management is a critical component of compensation management. It involves
setting performance goals and expectations for employees, providing feedback on their
performance, and linking their compensation to their performance.

Legal Compliance:
Your compensation must comply with various laws and regulations, such as minimum wage laws,
anti-discrimination laws, and the Fair Labor Standards Act (FLSA).

3-P Concept in Compensation Management

What is 3P salary?
3P salary is a salary payment system designed to reflect three factors in each individual's income:
Position, Person, Performance

Position (P1) - Salary based on the job position.

Person (P2) - Salary based on individual capabilities.
Performance (P3) - Salary based on job performance.

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6th Semester BBA Compensation and Performance Management

Example
Applying 3P salary for the Marketing position with the following parameters:
 P1 = $5,000 is the basic salary for the Marketing position.
 P2 = $2,500 is the income based on the employee's capabilities.
 P3 = $4,000 is the additional salary paid due to the employee's work effectiveness
exceeding the target.
The total salary that the company needs to pay to this Marketing employee based on the 3P
components is:
P = P1 + P2 + P3 = $11,500
1. Pay for Position
Pay for Position (P1) is salary based on the job position.
 Objectives: The objective of Pay for Position is to ensure fair compensation for employees
based on their job roles and market standards. It aims to attract and retain talent by offering
competitive salaries for specific positions.
 Key measures: Pay for Position focuses on the specific job positions within the
organization. The salary is determined based on the market value, job complexity, required
skills, and responsibilities associated with each position.
 Best for: Pay for Position is commonly applied in organizations where job roles and
responsibilities are well-defined, and there is a clear market benchmark for each position.
It is commonly used in traditional hierarchical structures.
2. Pay for People
Pay for People (P2) is salary based on individual capabilities.
 Objectives: The objective of Pay for People is to recognize and reward employees for their
individual competencies and contributions. It encourages skill development, performance
improvement, and helps recognize the value of specialized knowledge.
 Key measures: Pay for People emphasizes individual capabilities and skills. The salary is
determined based on an individual's qualifications, experience, expertise, and unique
contributions to the organization.
 Best for: Pay for People is often applied in organizations that value individual expertise
and want to incentivize employees to continuously enhance their skills. It is commonly
used in knowledge-based industries or organizations with flatter organizational structures.
3. Pay for Performance
Pay for Performance (P3) is salary based on job performance.
 Objectives: The objective of Pay for Performance is to motivate employees to perform at
their best and achieve organizational goals. It encourages a performance-driven culture and
rewards employees based on their measurable contributions to the company.
 Key measures: Pay for Performance focuses on an employee's performance and
achievements. Key Performance Indicators (KPIs) or performance metrics are established
to evaluate employee performance, and salary increases or bonuses are linked to the
achievement of these metrics.
 Best for: Pay for Performance is widely used in various industries and organizations. It is
particularly effective in sales-driven environments or roles where individual performance
can be easily measured and quantified.

Pros and cons of 3p salary implementation

3P salary is a salary payment system designed to reflect three factors in each individual's income:

Sangeetha K.K, Assistant Professor, Dept. of BBA, RJSIMS

6th Semester BBA Compensation and Performance Management

Pros of 3p salary implementation

 Ensuring fairness internally: Employees in the same position but with different salaries
can raise questions. The 3P salary system helps employees understand that working
efficiently and achieving results will lead to higher salaries and better income. This also
helps employees achieve their own goals and contribute to the company's overall
objectives.
 Ensuring fairness externally: To determine appropriate salaries for each position and
scale, businesses often conduct market surveys to grasp the appropriate salary levels based
on reality. This survey also helps businesses offer competitive salaries to attract talent
without devaluing them compared to the general market.
 Creating motivation for business development: When implementing the 3P salary system,
employees will have a clear understanding of the salary structure. As a result, employees
will be motivated and self-driven to accomplish their tasks to achieve the best results. This
will prompt the business to reevaluate its operations and adjust salaries accordingly for
each individual.

Cons of 3p salary implementation

 Complexity and Time-consuming: Building and implementing a 3P salary system can be
a complex and time-consuming process. It requires thorough job analysis, competency
framework development, and continuous evaluation of performance results. This may
require additional resources and expertise, especially for larger organizations.
 Subjectivity in Evaluation: While the 3P salary system aims to introduce objectivity, there
is still room for subjectivity in evaluating individual capabilities and setting performance
metrics. Different evaluators may have different interpretations, leading to potential
discrepancies and disputes in salary determination.
 Potential Demotivation: If the performance metrics and KPIs are not properly defined or
communicated, employees may feel demotivated or unfairly treated. A poorly implemented
3P salary system can create a sense of inequality, especially if the evaluation criteria are
not transparent or if employees perceive the system as favoring certain positions or
individuals.
 Resistance to Change: Introducing a new salary system may face resistance from
employees who are accustomed to traditional salary structures. Change management
efforts, effective communication, and training programs are essential to overcome
resistance and ensure a smooth transition.

Compensation as Retention Strategy

What goes into a Compensation Package
Compensation includes the salaries, wages, benefits, bonuses, and incentives provided to
employees by employers in exchange for the work they do. Group health insurance coverage,
short-term disability insurance, and retirement contributions are often part of a total compensation
package.
Compensation plays a major role in acquiring talented employees and driving productivity. The
quality of compensation packages determines the quality of an organization’s employees, how well
they perform, and whether or not they are engaged in the work they do.
There are certain legal requirements and internal and external compliance standards that basic
compensation packages must meet, but attracting and retaining skilled, high-performing, engaged

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6th Semester BBA Compensation and Performance Management

employees requires competitive compensation and benefits packages that go beyond those that
meet the minimum legal requirements.
Paid leave, wellness programs, flexible working schedules, stock options, remote and hybrid work
alternatives, and other employee perks are additional benefits offered in competitive compensation
packages.

How Does Compensation Affect Employee Retention?

Employees move on to other positions for many reasons, including better work-life balance, lack
of growth opportunities and low company morale. Often, compensation and retention are two sides
of the same coin. Opportunities for growth and the highest pay are the primary reasons employees
remain in their jobs. While people seek tangible and emotional benefits at work, compensation
remains critical in retention efforts.
Meeting employees’ needs makes them more likely to stay with your organization. Fair salaries
and benefits make them feel valued, engaged and motivated, increasing productivity. Low pay
leads to high turnover. Employees who lack commitment to your organization are more likely to
seek alternate employment. In the meantime, they’re less productive, affecting your customer
retention and company culture.

Why Does Retention Matter?

Your ability to keep employees happy significantly impacts your organization’s performance,
culture and profitability. Retaining the team you already have reduces the expense of training and
onboarding new hires. Additionally, robust retention programs can attract top-tier talent when you
have open positions.
High employee turnover can devastate your bottom line, from the cost of replacing employees and
losing their skills and knowledge to the time and effort HR and management must spend recruiting
replacements. When retention is high, they can focus on more productive aspects of their roles,
such as effective performance management — developing employees to perform at their best and
aligning with organizational goals.
Poor retention also has a marked effect on employee morale, productivity and engagement. Good
retention strategies foster a positive work environment with committed team members who feel a
sense of purpose in their roles. A comprehensive compensation package that comprises tangible
and intangible benefits, like work-life balance and flexibility, meets employees’ needs and creates
a sustainable and cost-effective environment.

7 Compensation Strategies to Improve Employee Retention

Compensation strategies are the methods your organization uses to handle pay and benefits,
including determining the best way to calculate raises and bonuses and setting salary ranges.
Companies use many tactics to attract and retain talent, and some of the most effective include the
following.
1. Align Salaries With Strategy
The COVID-19 pandemic has significantly changed workplaces worldwide, and many businesses
are reexamining their salary structures to compensate for talent shortages, remote work and
inflation. If you’re considering updating your employee retention strategy, adjust compensation
accordingly and create pay equity among your teams. Though salary adjustments can be expensive,
they are still more cost-effective than hiring, training and onboarding.

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6th Semester BBA Compensation and Performance Management

2. Provide Complete Benefits and Rewards

Compensation and raises are only one part of a compensation strategy. Employees stay for many
reasons, and desirable perks have a considerable influence. Examine your current benefits and
rewards package and ask your team for suggestions. Possible improvement opportunities include
mental and physical health support, financial wellness tools and stress management.
Work-life balance is another opportunity to augment your benefits, especially among certain age
groups. Indeed, 60% of Gen Z employees claim it’s the most critical factor when evaluating a new
job opportunity. Consider improving your package to include accommodations like remote work
and flexible hours.
3. Develop a Robust Rewards Program
Rewards are a sincere and motivational way to show employees you appreciate their hard work.
Workers who feel recognized are more likely to stay in their positions, so create a structured
recognition plan. Goal setting and regular check-ins with management can be invaluable,
providing employees complete clarity on your expectations and how to meet them.
Combine regular and effective performance reviews with acknowledgment of team members’
accomplishments. Money is a powerful motivator, but employees also appreciate positive and
public feedback.
4. Provide Clear Growth Roadmaps
An effective compensation strategy includes growth and professional development opportunities.
When you focus on retaining employees, it’s in your best interest to help them progress in their
career paths, so they can continue adding value to your organization. Learning opportunities are
essential to your retention efforts, as employees can evolve within their position’s requirements.
Take an active role in goal setting with employees, and consider incentivizing professional
development achievements. This strategy motivates employees to better themselves and shows
them you’re invested in their growth.
5. Focus on Pay Transparency
Employees who believe they earn fair compensation are more likely to stay. Develop a
communication strategy where you explain why your employees receive specific payments and
how they can improve their earnings. Train your managers to engage in pay-related
communications to openly discuss compensation with team members.
6. Improve Work Environment and Company Culture
Feeling distressed can motivate people to look for a new job. Ensure employees at your physical
location are comfortable in your space by keeping it well-lit, warm and ventilated. In addition,
being part of an encouraging team is a powerful motivator, so create an authentic and value-based
company culture where they can thrive.
7. Work With Experienced Consultants
Developing a compensation strategy is a complex process — professional compensation
consulting can help you create an effective system. Professional input can help you with market
analysis, developing workable salary structures, ensuring pay equity and designing incentive
programs. They will also keep you compliant with current regulations and best practices.

Sangeetha K.K, Assistant Professor, Dept. of BBA, RJSIMS

6th Semester BBA Compensation and Performance Management

Compensation Policies

What is a compensation policy?

A compensation policy is a set of principles, guidelines and strategies established by a company
or organization to determine how it will remunerate its employees based on their work, skills,
experience and contribution to the company.
The aim of this policy is to establish a fair and coherent compensation system that attracts,
motivates and retains talent within the organization. It can also help maintain the company’s
competitiveness in the job market, and align employees’ interests with the company’s overall
objectives and performance.
The compensation policy first determines the relative value of each position within the
organization, using job evaluation methods. It then establishes salary ranges for each job level,
based on the job market, required skills and performance.
The key elements of a compensation system can also include various forms of benefits, such as
bonuses, commissions, shares, fringe benefits (insurance, paid leave, etc.), and their allocation
according to individual and/or collective results.
An attractive, well-designed compensation policy helps to create a motivating and fair working
environment, while supporting the organization’s overall objectives. It must be in tune with the
company’s culture, and evolve in line with internal and external changes that may affect the
organization’s dynamics.

Why is it important to apply a salary policy?

Reason 1: Social justice
A salary policy establishes a fair framework for employee remuneration. This ensures that salaries
are determined consistently and based on objective criteria such as experience, skills and
contribution to the job. A fair pay policy helps to prevent pay discrimination and promote a culture
of equality within the organization.
Reason 2: Attracting talent
A competitive wage policy helps attract qualified and experienced talent. When salaries are
aligned with the labor market and offer competitive advantages, the company is more likely to
recruit the best candidates for vacant positions.
Reason 3: Employee loyalty
An appropriate compensation policy can contribute to employee retention. Fair and competitive
salaries are incentives for employees to stay with the organization rather than seek
opportunities elsewhere.
Reason 4: Motivation and commitment
A transparent, performance-related pay policy can motivate employees to give their best.
Knowing that their efforts will be rewarded, employees are more likely to invest themselves fully
in their work and improve their productivity.
Reason 5: Confidence
A clear pay policy establishes a climate of trust between employer and employee. When
employees understand how their compensation is determined, they are more likely to feel valued
and respected by the organization.

Sangeetha K.K, Assistant Professor, Dept. of BBA, RJSIMS

6th Semester BBA Compensation and Performance Management

What steps should you take to create an attractive compensation policy for your company?
Creating an attractive compensation policy within a company requires a well thought-out, strategic
approach.
Step 1: Analyze the job market
Start by conducting an in-depth study of the job market to understand salary trends and
compensation levels for similar positions in your sector and region. This will help you determine
where your company stands in relation to the market.
Step 2: Evaluate job categories
Identify the different positions within your company and carry out a job evaluation to determine
their relative value in terms of the responsibilities, skills and experience required.
Step 3: Setting salary scales
Based on market data and job evaluations, establish salary ranges for each job level. These scales
must be competitive, while taking into account the company’s budgetary constraints.
Step 4: Define performance criteria
Identify the individual and/or collective performance criteria that will be used to determine
salary increases, bonuses and bonuses. Make sure that these criteria are clear, measurable and
aligned with the company’s objectives.
Step 5: Integrate employee benefits
Include fringe benefits (insurance, paid leave, retirement, etc.) in your compensation policy.
Benefits can be an attractive element in attracting and retaining talent.
Step 6: Promote transparency
Communicate transparently with employees about compensation policy. Explain how salaries
are determined, what the performance criteria are, and what opportunities there are for
advancement within the company.
Step 7: Consult stakeholders
Involve managers, employees and human resources in the compensation policy development
process. Take their comments and needs into account to create a more inclusive and relevant
policy.
Step 8: Communicate
Once the compensation policy has been finalized, make sure it is implemented consistently and
fairly. Communicate clearly and effectively with employees about the changes and benefits
of the new policy.

Models of compensation systems used in companies

Model 1: Fixed salary
This is the simplest and most common compensation model, where employees receive a regular
fixed salary, usually on a monthly basis. This model offers financial stability to employees,
especially if they have a permanent contract.
Model 2: Commission-based remuneration
This modelemployees on the basis of sales or sales targets achieved. Employees receive a
percentage of sales achieved or contracts signed, which motivates them to increase their
productivity and performance.
Model 3: Pay for performance
In this model, employees arecompensated according to their individual or team
performance. thosePerformance criteria are generally linked to company objectives, and are used
to determine salary increases, bonuses or bonuses.

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6th Semester BBA Compensation and Performance Management

Model 4: Premiums
In this model, bonuses are awarded on a discretionary basis by management or managers for
outstanding contribution or exceeding employee expectations.
Model 5: Profit sharing
More and more companies in France are introducing employee profit-sharing schemes.
Employees receive a share of the company’s profits, which encourages them to contribute to
the company’s profitability.
Model 6: Share purchase
This model is often used in start-ups or listed companies. Employees are offered the opportunity
to buy company shares at a preferential price, giving them an incentive to contribute to the
company’s long-term performance.

Compensation Issues

Compensation issues are common challenges for organizations, including pay disparities,
insufficient compensation packages, opaque compensation practices, and challenges with
performance-based remuneration.
Effective compensation policies and procedures can address these issues by creating
precise pay guidelines, performing routine compensation audits, and training managers and HR
specialists on pay equality practices.
By developing a fair and competitive compensation plan that considers the business’s and
its employees’ specific requirements and objectives, organizations can recruit and retain top talent,
prevent pay inequalities, and better align employee behavior with their goals.

Ten Compensation Issues that Organizations May Face

1. Pay equity: When workers believe their salaries are unjust or unequal to those of their
coworkers at the company, it can cause low morale, discontent, and attrition.
2. Lack of transparency: Employees may not understand how their pay is set when firms don’t
explain their compensation practices, which can breed mistrust and unhappiness.
The social media toolkit provider for small businesses, Buffer, perhaps takes the most
unconventional approach by posting its employees’ salaries publicly for all to see.
3. Insufficient market research: Businesses that do not perform proper market research to
identify competitive pay rates may give remuneration that is not competitive, which can make it
challenging to recruit and keep talent.
4. Lack of differentiation: High-performing employees may feel undervalued and depart for
greater possibilities elsewhere when firms must distinguish compensation based on performance,
abilities, and experience.
5. Minimal perks: Companies that provide limited benefits may cause low morale and problems
keeping talent since employees may believe that their overall pay needs to be increased.
6. Lack of flexibility: Employees may believe that a company only appreciates their preferences
and requirements if it offers flexible remuneration packages, such as the option to work remotely
or select a benefits package that suits their demands.
7. Lack of alignment with corporate goals: Employees may not be motivated to work towards
those goals when remuneration practices are out of line with those objectives, making them more
difficult to attain.

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6th Semester BBA Compensation and Performance Management

8. Legal compliance: Businesses that violate rules about remuneration, such as anti-discrimination
or minimum wage legislation, risk legal repercussions as well as reputational harm.
9. Communication breakdowns: Businesses need to inform employees properly of modifications
to pay rules or other changes to avoid confusion and discontent among them.
10. Failure to update policies: When businesses frequently evaluate and update their
compensation plans to account for shifting market dynamics or employee demands, they refrain
from providing outdated or uncompetitive pay packages that make recruiting and keeping top
people difficult.

How to Address Compensation Issues in Organization?

Step 1: Conduct a compensation audit: Review your present compensation rules and practices
before conducting a compensation audit.
Determine any problems, such as salary disparities, a lack of distinctiveness, or poor benefits.
Step 2: Get employee opinions: Involve workers and ask them for input on pay practices and
policies. You can conduct surveys, focus groups, or one-on-one interviews.
Use this feedback to pinpoint areas that need work and learn more about your staff’s requirements
and expectations.
Step 3: Conduct market research: Do rigorous market research to identify competitive pay rates
for your sector and area. Use this data to assess your present pay rules and procedures and pinpoint
improvement areas.
Step 4: Create a compensation plan: Create a thorough compensation strategy that aligns with
your firm’s objectives and core values based on the results of the compensation audit, employee
input, and market research.
Clear standards for deciding on salary, benefits, and other compensation-related choices should be
part of this plan.
Step 5: Execute changes: Put into practice the adjustments noted in your compensation strategy.
This can entail changing pay scales, enhancing benefits packages, or creating pay structures
depending on performance. Be careful to inform staff members of these changes understandably
and openly.

Sangeetha K.K, Assistant Professor, Dept. of BBA, RJSIMS