Many of us in our lives have come across the term “compensation” when it comes to getting paid for the work we do, which could either be full time or part time engagement. Compensation is nothing but the reward the employees get for investing their energy into something meaningful and noteworthy in the eyes of their employers. It is one of the most critical factors of motivation in the field of HR management.
Compensation may include direct cash payments or indirect cash payments in terms of incentives and perks to motivate employees to struggle for enhanced level of productivity. Nevertheless, it ought to be competitive in order to attract the best talent in the industry. The compensation you set should cater to the demand and supply of workers in the industry. You may be required to set premium pay levels to catch the attention of skilled professionals, already working for other organisations.
Compensation management objects to assist an organization in achieving its strategic goals in conjunction with internal as well as external equity. Where “internal equity” ascertains that extremely qualified people or high-level positions are paid comparatively better, “external equity” ascertains that the jobs are justly compensated vis-à-vis jobs of the same kind in the market.
Job evaluation is a very useful technique to frame a satisfactory, rational and balanced compensation system within an organisation. It makes employee promotions and transfers more easily acceptable, and enables the adjustment of existing job positions within the existing compensation structure. This is also evident with the removal of disputes and grievances among employees.
The compensation payable to the employees is composed of three elements:
- Basic compensation, also known as Salary/Wage
- Ancillary compensation, also known as Fringe Benefits
- Incentive compensation
Wage and Salary are the important constituents of compensation. Where, wage refers to the remuneration paid to workers on hourly basis, salary refers to the remuneration paid to white-collar employees or managers on monthly basis.
System of Wage Determination
Wages are usually determined either on the basis of time spent at work or number of units produced in a given amount of time. The following are the two types of wage systems
Time-Wage System: It is a system in which remuneration is provided on the basis of time taken to complete a particular job which can be on hourly, weekly or daily basis.
Piece-Wage System: In this method the units of output are considered as the basis of compensation. In which case, a good performance is the one which requires less time to complete the task assigned.
Incentives
Any sort of payment to the employees in addition to their wages or salaries, are called Incentives. These are based on their performance level and productivity, in terms of better production, cost efficiency, or both.
Fringe Benefits
Fringe Benefits are provided to the employees having short-term or long-term impact such as,
- Retirement benefits: These benefits are provided to the employees, after they retire from the organisation, such as provident funds, pension schemes, gratuities, and so on.
- Compensation benefits: These benefits are applicable under Workmen’s Compensation Act, 1923 and under contractual obligations. The Act provides compensation to the employees in the events of fatal injuries or otherwise, during the course of employment. Contractual obligations require the employer to pay 3 months’ wage/salary or the sum specified in the terms of employment.
- Insurance benefits: These benefits are payable to employees covered under the Employees State Insurance Act, 1848, who need to contribute to the scheme along with the employer.
- Payment for non-working days: These comprise weekends, gazetted holidays, religious holidays and leaves, including casual leaves, sick leaves, maternity leaves and annual leaves.
- Other benefits: Some organisations also provide benefits such as reimbursement of educational expenses, subsidised housing, subsidised meals, child care facilities, recreational facilities, transportation facilities, etc.
- Perquisites: These include company car, free accommodation, paid holiday trips, stock options, etc.
Employee Stock Options
An Employee Stock Option Plan (ESOP) is referred to as a privately-awarded call option (or shares) given to the employees of a company, as an incentive to improve the market value of a company, but which cannot be traded in the open market. Put it simply, an ESOP is an option to buy the company’s share at a price, which could either be the market price, or a preferential price. Here, market price is the price of the share listed on the stock exchange, and preferential price is the price lower than the existing market price. If the company is yet to go public or list its shares in the stock exchange, the share price would be fixed by the management.
ESOs give employees a choice of right to buy predefined amount of the company’s shares at the current or set price, within a specified time period of 10 years, after which the options get expired. If the stock price increases within the time limit, the employee has the right to exercise the ESO by purchasing the discounted shares and selling them off simultaneously at a higher market price. But if the stock price goes below the strike price, this is not possible. This is why ESOs are used by companies in place of high salaries to encourage employees to increase the company’s worth.
There are three primary types of ESOs:
- Non-statutory ESOs: These are the standard options with a stipulation that an employee will not be able to exercise the option within a vesting period of 1-3 years, or earn the margin between the strike price and the current price, multiplied by shares sold. These options are taxed at the full income tax rate and do not qualify for capital gains tax rates. Some of the options are locked with a ‘graduated vesting’ scheme called phased vesting.
- Reload ESOs: These ESOs begin with a non-statutory ESO, but once the ESO is exercised where the employee earns a profit, a “reload” of the ESO is awarded to the employee in which new options are issued at the current market price that becomes the new strike price.
- Incentive Stock Options (ISOs): These options are subject to increased legislation developed to reduce taxation. The employee needs to wait for a year before exercising the ISO to buy the stock, but not sell it until one year is over upon the purchase. This varies considerably from the simultaneous buy-and-sell exercise of non-statutory ESOs, and poses a higher risk on account of the risks associated with one-year stock holding period, as the stock price may decline. But, ISOs are taxed significantly lesser than the non-statutory ESOs at a long-term capital gains tax rate instead of income tax rate. These are awarded to top level management.