Compensation Planning

Compensation has long been considered one of the most important organizational rewards because it allows employees to obtain other rewards. Compensation management entails a mechanism that connects employee efforts, performance and outcomes with organizational goals and objectives. Since a large number of employees work in the organization, therefore, managing compensation in the organizational context involves many considerations for designing and implementing rewards for employee’s work and performance, which needs to be developed for maintaining motivation and productivity of employees on one hand and organizational effectiveness on other hand. These considerations in compensation management require managerial decision-making and appropriate planning.

Thus organizations need to decide for the employee efficiency and organizational cost control, which can be broadly classified as under:

  •  Level of compensation Is adequate to attract and retain competent employees necessary for certain competitive advantage for the organization.
  • Structure of compensation to facilitate the attainment of an organization’s strategic goals and objectives.
  • System of compensation is perceived by employees as fair and equitable and complies with government regulations.

Compensation level Planning: Heneman and Schwah define pay level as follows:

Pay level is the average of several wages or salaries in the organization. The average may be based on individual pay rates for a single position or on pay averages for a number of positions”.

Compensation level represents an organization’ average compensation relative to that of other competing organizations and is often labeled as leading matching or lagging the market. An organization with a policy of leading the market offers higher than the average compensation of the relevant labour market; a policy of lagging the market signifies lower than market average compensation; and policy of matching the market indicates compensation at the relevant labour market average.

Compensation level decisions made by organizations can significantly impact individual and group level consequences, including performance, skill and development, skill development, work-related attitudes and workforce composition. Compensation level and benefit policy can determine what types of employees are attracted to he organization by signaling job seekers to less visible organizational attributes. These policies will determine whether or not employees are willing to continue to work for the organization. Organizations with higher compensation level should experience increase in both individual and organizations to be more selective when hiring and to retain highly qualified employees. High compensation levels may also improve employee and resource efficiency by decreasing employee’s unproductive behaviors. If the compensation level or benefit level is not satisfactory, the desirability of movement will increases and it is more likely that withdrawal behaviors such as tardiness, absenteeism and turnover will increase. Unsatisfactory compensation and benefit levels may also reduce the motivation of employees and eventually negatively affect individual, group, and organization performance.

Compensation Structure Planning: Heneman and Schwab define pay structure as follows:

“Pay structure is the hierarchy of pay rates or level among jobs in an organization”.

An organization’s compensation structure means the array of compensation rates within the organization which represents the degree of slope in its compensation policies. Characteristics of a particular compensation structure include the number of levels in the structure, the size of the compensation differentials between each level in the structure and the rate at which employees can process through each level in the structure.

Compensation level planning is decided at the top levels of the organization. These policy decisions provide guidelines on:

  • Minimum and maximum levels of compensation keeping in view organization’s ability to pay, legal regulations, trade union’s influence and competitors compensation structures.
  • The general relationship among levels of compensation and marketplace rate. The organization can choose to pay market (lead), at market (match) or below market rates (Lag). Organizations choosing to pay compensation above marketing rates are likely to be more attractive to talented candidates for employment. Paying at market rate helps organization to still attract and retain good candidates to their organization. However, choosing to pay below market rate may challenge in attracting and retaining best employees. The resultant effect can be disastrous on the long run due to high employee turnover.
  • The division of total compensation amount into fixed and variable pay. Fixed refers to pay for position and variable pay for performance. Pay for performance can be divided into two broad categories viz. merit pay increases based on individual performance and variable pay for accomplishing a p[particular objective which is generally a one-time payment or bonus (often called performance bonus).

Compensation structure can be broadly characterized as “egalitarian” a term that indicates a compressed compensation distribution or as ‘Hierarchical’, which indicates more widely dispersed compensation.



According to equity theory, employees evaluate ; exchange relationship’ on the basis of comparisons of their perceived ratios of inputs and outputs to the perceived rations of other’s input and outputs. When employees perceive inequity, they may respond with a host of potentially negative reactions in order to restore equality in their exchange relationships. As compensation structure become too hierarchical, organizational performance may be adversely affected employees will become less cooperative and less inclined towards teamwork. These negative consequences may be exacerbated if a hierarchical becomes a means of signaling organizational value, spawning feelings of social, psychological and economic injustice among employees. While overly hierarchical compensation systems should be associated with negative organizational outcomes, equity theory also suggests that overly egalitarian compensation structures will be similarly detrimental. Greater level of knowledge, skills and abilities should be associated with grater compensation and therefore compensation systems that provide insufficient differences for human resources yield feelings of inequity on the part of employees with greater levels of knowledge, skills and abilities.

Frank’s work on employee’s relative standing suggests that employees may be more likely to accept perceived inequality when they are paid above their managerial products, that is, the values of their organizational contributions. In overly hierarchical compensation structures, lower level employees may have feelings of inequity because of their comparatively lower compensation. High compensation levels may alleviate these feelings of inequity. Thus the effects of particular compensation structures on employee behavior depend upon compensation level.

HR-Professionals 12


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