Tuesday, May 17, 2011

Explain the basic principles of compensation policies and its objectives.

Explain the basic principles of compensation policies and its objectives. Discuss the executive compensation system of any organization you are familiar with. Does compensation system motivate the executives, explain with examples?

Answer. Compensation is the HRM activity that deals with every type of reward that individuals receive for performing organizational tasks. It is basically an exchange relationship. Employees exchange their labour for financial and non-financial rewards. Financial compensation is both direct and indirect. Direct financial compensation consists of the pay an employee receives in the form of wages, salary, bonuses, and commissions. Indirect financial compensation (also called “benefits”) consists of all the rewards that are not included in direct compensation, such as vacation time and insurance coverage.

From the employees’ perspective, pay is a necessity in life. The compensation received from work is one of the chief reasons people seek employment. Pay is the means by which they provide for their own and their families’ needs. For some people, compensation may be the only (or certainly a major) reason why they work. Others find compensation a contributing factor to their efforts. But pay can do more than provide for employees’ psychological needs. It can also indicate their value to the organization.

Compensation Policy has the objective to establish and maintain a compensation program that will:
• Attract and retain qualified employees at all levels of responsibility who perform in a manner that permits the College to achieve its objectives and goals;
• Reflect the relative value of jobs;
• Be externally competitive and internally consistent and fair;
• Provide the flexibility (based upon availability of funds) toward employees on the basis of individual performance and contribution to the achievement of college goals;
• Foster good employee understanding and relationships; and
• Comply with all Board of Regents, State, and Federal Laws and regulations.

Traditionally, the focus of compensation management has been primarily on enabling an organization to recruit and retain employees while complying with legal and statutory requirements. Pay was primarily related to status and hierarchical position. It is now being viewed increasingly as the key to acquire a competitive advantage.

Innovations in compensation are considered necessary to do more with less by reducing labour cost per unit of output, motivating employees to higher performance, providing an impetus to skill development and higher quality and so on.

Some Basic principles
1. There general level of wages and salaries should be reasonably in line with that prevailing in the market. The labour market criterion is most commonly used.
2. There should be definite plan to ensure that differences in pay for jobs are based upon variations in job requirements, such as skill effort, responsibility or job or working conditions, and mental and physical requirements.
3. The plan should carefully distinguish between jobs and employees. A job carries a certain wage rate, and a person is assigned to fill it at that rate. Exceptions sometimes occur in very high-level jobs in which job-holder may make the job large or small, depending upon his ability and contributions.
4. Equal pay for equal work, i.e., if two jobs have equal difficulty requirements, the pay should be the same, regardless of who fills them.
5. An equitable practice should be adopted for the recognition of individual differences in ability and contribution.
6. There should be a clearly established procedure for hearing and adjusting wage complains.
7. The wage should be sufficient to ensure for the worker and his family reasonable standard of living.
8. Prompt and correct payments of the dues of the employees must be ensured and arrears of payment should not accumulate.

Executive compensation
The pay of executives is merely a special case within the topic of compensation, but it does have several twists that deserve attention. First, the base salaries of executives are higher than those of low-level-managers or operative personnel. Second, executives frequently operate under bonus and stock option plans that can dramatically increase their total compensation. A senior executive at General motors, IBM, Data General, or General Electric may in good year earn $500000 or $1000000 or more on top of his base salary. Executives receive perquisites or special benefits that others do not.

How do organizations justify such extraordinary salaries for their executives? The answer is simple: economics and motivation. In economic terms, we know that top managers are expected to demonstrate good decision making abilities. This skill is

not widely held in our society. As a result, the supply of qualified senior executives is scarce, and organizations have bid up the price for this talent. High salaries also act to motivate both top level-managers to perform well in order to keep their jobs.

Retaining and rewarding leadership is a hot button issue facing most organizations. Increasing complexity of hiring leadership talent in the face of burgeoning market demand is bringing companies under pressure to retain their top talent. “The only way to reward and retain top leadership is by sharing the success of the company with them,” says Piyush Mehta, senior V-P, Genpact, India.

Motivating for high performance can cost a lot of money. Not everyone can be motivated by money alone, however much. Incentive pay plans should be designed not only to reward good performance but also to minimize the negative side-effects, such as conflict and grievance. At times it is difficult to develop a valid, equitable and acceptable means of performance. Many pay plans fail because of either not being suited to the particular situation or because of poor implementation. It is essential to consider the following aspects before designing a pay plan to motivate performance:
™ preference of individual employees;
™ size of pay rewards for high performance;
™ method of motivating individual job performance;
™ subjective

For effective and sustained motivation, the reward must be prompt and immediate. The example of Foxboro has been quoted. In its early days, the company's very survival depended on technical innovation. Late one evening a scientist walked into the president's office with a working prototype. The president was dumbfounded by the elegance of the solution and sought to reward him immediately and on the spot. Rummaging through the drawers of his desk, all he could find was a banana and this had to suffice. This was the forerunner of the 'gold banana' concept, a very apt and fitting reward. Likewise, Thomas Watson Snr. had made a practice of writing out a check on the spot for any unusual achievement that he observed.

Example: Signet
Signet is the world’s largest specialty retail jeweler by sales, with stores in the US, UK, Republic of Ireland and Channel Islands.

The Compensation Committee believes that to be effective, compensation policy must be based on sound, clear principles which are well understood and recognize the long term interests of the Group, its shareholders and employees.
(i) Signet’s primary business objective is to deliver results which should consistently outperform the average of the industry sector.
(ii) It is recognized that to consistently deliver above industry average performance Signet will need to retain, and where necessary attract, executives of well above industry average ability and leadership potential.
(iii) It is recognized that in order to retain or recruit senior executives of the caliber necessary to deliver above industry average results, the Group must provide very competitive levels of total compensation. Therefore, the total compensation of Signet’s senior executives will be targeted at the median of industry compensation, with an acceptable range of + or – 10 percentile points. Positioning within this range will be based on performance (both of the Group and the executive), potential (i.e. the executive’s potential to grow in responsibility and performance), and scarcity (i.e. the availability of candidates to replace the executive should he/she leave the Group). As noted in principle (iv) below, when the Group significantly outperforms the industry, the performance based elements of compensation should result in significantly higher total compensation than that achieved by executives in competitor companies.
(iv) Total compensation for executive directors and other senior executives should be highly geared towards performance with the proportion of “at risk” pay increasing according to: a) the level of performance achieved, and b) the ability of the executives to influence results. Excluding pension contributions, the provision of a company car and private health insurance, there should only be one element of guaranteed compensation: base salary. The performance related portion of total compensation should separately reward short term performance (through the annual bonus) and long term performance (through share and other long term incentive awards).
(v) Surveys will be undertaken on a regular basis to ensure that total compensation packages remain in the percentile range described in (iii) above. Recognizing that more than 70% of the Group’s sales and profits are generated in the US and that significant compensation differences exist between the US and the UK markets, separate surveys are conducted in each country.

The components of total compensation:
(a) Base salary

The base salary of each senior executive reflects the size and scope of his/her responsibilities and is reviewed annually, based upon individual performance, experience, surveyed competitive data and trends and geographic location of each position as well as the movement of base pay in the Group.

(b) Annual bonus plan
Annual bonus targets are set by the Compensation Committee each year after considering the Group’s current business plans. There is a maximum bonus level set each year on such awards, which is equal to twice the target level, and a threshold performance below which no payments are made.

(c) Share option plans
The Compensation Committee believes that executive share options are an appropriate element of compensation in order to execute the compensation principles set out above, and are an effective tool to incentivize executives to deliver the long term performance needed to generate strong returns to shareholders.

It is the policy of the Compensation Committee that all employees, including directors, who satisfy certain qualifying conditions, should have the opportunity to participate in the equity of the Company. This is achieved through savings-related share option plans, for which invitations are normally made annually. Under the relevant legislation the exercise of these share options is not subject to performance criteria.

(d) Long term incentive plan
The Company has established a Long Term Incentive Plan. The policy to date has been to make annual awards expressed as a percentage of salary with vesting dependent on the achievement of challenging performance conditions set by the Compensation Committee at the time the awards are made.

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