Q-1-Unit-11-Executive Compensation

Structure:

11.1 Introduction

Objectives

11.2 Components of Executive Compensation

Calibration of executive compensation to performance

Transparency of executive compensation

11.3 Executive Compensation Theories

11.4 Relationship between Fixed and Variable Pay

11.5 Performance Measurement in Executive Incentive Programmes

11.6 Executive Compensation and Organisational Strategy

11.7 Different Criteria of Executive Compensation

11.8 Summary

11.9 Glossary

11.10 Terminal Questions

11.11 Answers

11.12 Case study

11.1 Introduction

After studying the earlier units, you must be familiar with the quantitative tools used in designing a compensation plan. This unit discusses the standards that would be associated in Executive Compensation. Executive compensation is the financial compensation that a top executive receives within a corporation. This includes basic salary, any and all bonuses, shares, options, and any other company benefits. The high level employees are company presidents, chief executive officers (CEOs), chief financial officers (CFOs), vice presidents, occasionally directors, and other upper level managers. Executive compensation often includes short term incentives and a share in the equity of the company.

Learning Objectives:

After studying this unit, you should be able to:

· explain the concept and components of executive compensation.

· discuss the different theories of executive compensation.

· tell the relationship between fixed and variable pay.

· discuss the performance measurement in executive programs.

· state the different criteria for executive compensation.

11.2 Components of Executive Compensation

The process of selecting and hiring senior executives capable of motivating people and leading a company to its goal can be challenging. With concerned investors closely monitoring company performance, today’s businesses are under tremendous pressure to retain qualified executives once they hire them. Executive Compensation is negotiated between the potential executive and the employer. In today’s business world, executives enjoy more negotiating power than ever, as they can command a high salary and compensation plan owing to the tremendous need for capable candidates.

The components of executive compensation can be divided into three broad groups. Table 11.1 shows the components of executive pay.

Table 11.1: Depicts the Basic Components of Executive Pay

Components BenefitsBase pay Includes Cash salary, Flexible benefits, Statutory

benefitsLong-term incentives Includes cash, shareholder value focus, referenced

against peer groupAnnual incentives Includes delivery in cash, deferral, value-added

measures

Executive compensation includes:

Base salary

This is the basic salary paid to the executives excluding the bonuses. This is paid at the end of the month.

Bonuses

Bonuses are standardised in executive compensation plans, where there’s often more pay for good performance. This is tied to the performance of the business area that the executive manages.

Incentives such as stock options

Executives would prefer a share in the equity of the company instead of cash. The amount of stock options given to senior-level employees will depend on the type of the industry and the valuation of the company’s stock. Some companies offer executives a higher percentage of equity each year, based on company performance or shareholder return.

This is issued as a form of non cash compensation, and a call option on the common stock of a company. This is offered to management as part of their executive compensation package.

Deferred compensation plan

This refers to a plan established by an employer to provide benefits to an employee at a later date, such as after the employee’s retirement. This is highly beneficial for the employees, with respect to tax burden.

Severance package

This is an executive benefit which includes sick leave, an additional pay for the month of service and medical, dental or life insurance.

Signing bonus

Signing bonus is a sum of money paid to an employee to join the company. This is paid exclusively to full time employees of a company.

Flexible work schedules

This includes compressed working hours, communication facilities through any part of the world, part-time work, job sharing, and time off. This is very important in encouraging the top level employees of the organisation.

Prepaid compensation

This is a compensation given to the employees three or five years earlier than it actually gets payable. For example, this is similar to the prepaid balance in the mobile. It is paid in advance to retain the employees in the organisation.

Perquisites

This includes home entertainment allowance, club memberships, travel clubs, extra vacation, personal expense account, credit cards, medical expense and holiday gifts and so on. Some common executive perks paid in India are:

· Transportation: company car or car allowance, first class air travel or company airplane usage.

· Financial/legal assistance: financial planning, low interest loans, tax planning and tax preparation and legal counselling

· Club memberships: membership in Country Club or a Health Club, Luncheon Club and so on.

Unique features of executive compensation

Following are certain unique features of executive compensation:

· Executive compensation cannot be compared to wage and salary schemes of non-managerial employees of an organisation as the factors and variables are too many with in executive jobs and hence simple comparison of ratings is not possible.

· As opposed to the employment agreement of other employees, executives are not allowed the option of having unions and collective bargaining. It is their individual competence and contributions that are the deciding factors of their compensation package.

· Executive compensation is usually not based on individual performance measure, but based on the unit or organisational performance.

One needs to be creative when developing executive compensation plans. Including options like car allowances, life insurance, relocation payments, flexible start dates, signing bonuses, use of company-owned vacation property, health-club membership, tuition reimbursements, and other compensation will make the package competitive and attractive. Offering non-monetary incentives like these will help companies to attract talented candidates and also retain them.

11.2.1 Calibration of executive compensation to performance

Executives cannot just have a high package once they are designated in top positions of the organisations. There are many other focuses or factors on which they will be given the hike or compensation. The main

basic consideration is the performance. These days companies are quite serious about the performance of the employees. The performance is directly proportional to the financial growth of the company. Hence, a performance measurement tool is used to measure the performance of the executives.

Many companies use financial measures such as return on equity, return to shareholders, earnings per share, net income before taxes and other criteria while deciding executive performance rewards. However, a number of firms also consider non-financial organisational measures of performance when determining executive bonuses and incentives. Customer satisfaction, employee satisfaction, productivity and quality are other areas measured for executive performance rewards.

The strategy is usually based on the competitive analysis including the characteristics of each executive’s business strategy, operating environment and talent profile. The objective is to ensure that the best possible match is found and also a meaningful compensation is given with due consideration of the business strategy, operating environment and talent profile of the executive. In assessing the performance based rewards, components such as total compensation, base salary, annual incentives and the value of perquisites and retirement package are taken into consideration.

Here are a few questions that can help while deciding executive performance rewards:

· How does the plan ensure that the benefits and rewards are meaningful to the participants at all stages of their career?

· How do benefits and perquisites measure up to the given competitive practice, organisational culture and opportunities provided to other employees?

· Does the plan meet regulatory requirements?

· Do the programs offer optimal tax advantages for both executives and the company?

11.2.2 Transparency of executive compensation

Earlier, top executives of companies were kept in the dark when it came to compensation practices. However, past 1938, almost all countries of the world have made it mandatory to provide more understandable disclosure of the type of compensation paid to the executives. The companies are required to follow compensation policies that are simple, transparent and focussed.

Transparency refers to the policy wherein employees can understand their compensation program and can also know how it works for them. Many researchers have found that transparency can lead to greater levels of trust. The actual transparency would be to show the employees how the pay programs are being managed.

Making an organisation’s compensation plan more transparent can actually help executives understand that they are being compensated fairly for their hard work. To increase compensation transparency, organisations can provide accurate, up-to-date information about how much their peers earn in similar jobs and compare their salary increase scale to other organisations’ pay plans for similar jobs. Keeping the executive compensation plans consistent from year to year can also help in increasing transparency. 

Self Assessment Questions

1. Executive compensation is the ____________ a top executive receives within a corporation.

2. Executive Compensation is negotiated between the potential executive and the employer. (True/False)?

3. The stock options are paid to the senior level employees based on ________ and __________ of the company’s stock.

11.3 Executive Compensation Theories

Several theories have evolved on the subject of executive compensation. A few of them are discussed below.

Agency theory

This theory is based on the assumption that the primary relation of an executive is with the shareholders. According to this theory, shareholders design the compensation of the top executives, keeping in mind their mutual interests. This theory is viewed as a contract of resource holders (shareholders and the top executives). It is the agency between the shareholders and agents. The compensation is designed in such a way that it serves the best for the shareholders as well as the executives.

Tournament theory

This theory focuses on the compensation differentials between the top-level and the next level executives who aspire to become the CEO. Winners at one level enter the next level. By compensating the employees by their performance and promoting those ahead from one position to other higher position may not allow them to acquire all the skills of next higher positions. This means that compensation cannot help in acquiring skills. This has many drawbacks – for example, when a Vice President becomes the CEO, he may not acquire skills with pay differentials. This is a simple example for the drawback of tournament theory.

Social comparison theory

According to the social comparison theory (Festinger, 1954), the executive compensation plan is created by comparing with similar individuals. This ensures social justice and principles of equity. This theory is based on the idea that individuals always look for outside images in order to evaluate their own abilities.

Executive pay is a major issue in the corporate governance debate. As well as in practice as in theory, there always exists an argument as to how executive pay levels should be structured. A more conclusive understanding of executive pay would be based on considering executive pay as an outcome of socially constructed corporate governance arrangements, in which the actors involved have considerable discretion to influence the outcomes. Organisations should incorporate such a view while creating and explaining executive pay.

Self Assessment Questions

4. Organisations design their executive compensation based on three components, namely _______, _________ and _________.

5. Agency theory is viewed as a contract of resource holders. (True/False)

6. Social comparison theory helps the winners to enter from one level to another. (True/False)

11.4 Relationship between Fixed and Variable Pay

Globally, every company has more or less two kinds of pay – namely fixed pay and variable pay. Fixed pay is the base pay and is sufficient for the executive to live comfortably. This is the guaranteed amount given to the executive at the end of the month, even if the milestone is not achieved. The fixed pay remains more or less unchanged across the organisation, while, the variables, such as short-term and long-term incentives, increase or decrease.

Variable pay is the compensation given based on the performance or results. Organisations link their executive variable pay plans to individual, team and organisation performance.

Variable pay is a huge incentive and a reward directly proportional to the expectations of the organisation. The percentage of fixed versus variable varies according to the years of experience. The more senior the person is, the compensation becomes more variable. The reason for variable pay is the companies must keep their top 20 percent people happy who have higher rate in market. Variable pay is an effective tool through which organisations can reward their people based on performance and not on the years of experience.

The idea of variable component is to allow the employees to grow beyond their job and this is a common practice in the IT industry. When salary hike is announced, there is also a differential amount that is awarded to people. In India, the ratio of fixed to variable pay is 60:40, while in other countries it is 30:70. The ratio varies based on the role of the executive. Executives engaged in sales activities have a larger variable when compared to others. For others, the companies usually follow 80:20 ratio based on the person meeting the objective. Variable pay varies form one organisation to another and it does act as a performance enhancer. Most of the companies have defined merit pay plans but it is not sufficient to reward the employees. Hence, variable pay is a must to reward the key employees. The pay can be individual based, team based or organisation based. They can be in the form of profit-sharing, team poll and so on. This is always an added incentive to work with quality.

The popular thumb rule dictates that the variable pay is directly proportional to the level or responsibilities – the contribution an employee is able to make to the revenues or growth of the organisation. However, stand-alone roles like sales where the performance directly affects top-line revenues are an exception.

The most important advantage of including variable pay in executive compensation is to motivate the executives to perform better by providing incentives. It also strengthens the feeling that the organisation is sharing its profits with its employees, thus creating a sense of belonging among them and differentiates between high and mediocre performers.

Self Assessment Questions

7. The two kinds of global pay followed by organisations are _______ and _________.

8. Variable pay is the compensation given based on the ___________ or _______.

9. Variable pay may lead to issues between performers and non-performers. (True/False)

Activity 1:

Imagine you are the HR manager of a company and design the pay model for the executives.

Hint: Visit any company’s website and analyse the same to design the model in a similar way.

11.5 Performance Measurement in Executive Incentive Programmes

Most organisations use many ways for performance measurement. The common components of performance measurement include profitability, efficiency, quality, and time, value for shareholders, innovation (sometimes even inventions), customer satisfaction, and accountability.

Executive performance is closely linked to the company performance and the resultant value creation for the shareholders. Linking executive compensation to organisational performance becomes extremely important as executives are usually paid very huge pay packages.

Some of the important criteria that incentive performance should meet are:

· Capable of being lined up with shareholders’ reference.

· Describable.

· Controllable.

· Thorough communication.

Table 11.2 explains the performance management.

Table 11.2: Performance Measurement

Criteria Shareholder return based measures

Company specific measures

Line up with shareholder

Directly lined up Indirectly lined up

Describable Yes Typically DefinableControllable Limited to top tier

executive groupTypically more controllable to market volatility

Thorough communication

Yes Yes

The popular performance measurement criterion is Total Shareholder Return (TSR), which is based on stock options plan. The internal performance criteria are return on equity (ROE), earnings per share (EPS) and economic value added (EVA).

The external inputs for performance measure are:

· Following industry standards for short, medium and long term incentives.

· Identifying external value drivers to understand the state of the company.

· Understanding the relevance of any financial ratio.

Similarly, internal inputs for performance measures are:

· Understanding the internal value drivers.

· Focusing on key strategic objectives.

· Linking executive behaviour to business performance.

These are the important measures that influence executive incentives in any organisation.

Short-term incentives are payable for short-term performance objectives and long-term incentives are payable for long-term performance objectives. Short-term incentives are less problematic when compared to long-term incentives.

The benefits of performance based incentives are:

· Focuses on strategic goal.

· Helps in monitoring the performance of executives and also controlling over-payment of incentives.

Self Assessment Questions

10. Total shareholder return is based on stock options. (True/False)?

11. Executive performance is closely linked to ____________ creation and __________ performance.

12. Every company has ________ and _________ for performance measure.

Activity 2:

Learn what a CEO scorecard is.

Hint:http://money.cnn.com/magazines/fortune/fortune_archive/2006/10/30/8391732/index.htm.

11.6 Executive Compensation and Organisational Strategy

There is a big debate over how executive compensation can be related to organisational strategy. The business strategy plays an important role in the design of executive compensation. A company needs to create a dynamic work frame so as to achieve the proposed target and also take care of issues of pay equity and ethics associated with executive compensation. Arriving at a compensation package that fulfils the organisation strategy and also keeps the executives happy and satisfied is indeed a challenging task.

Some of the guidelines to achieve this are:

Base salary of executives

Base salary is a very essential and basic component of employee pay in organisations. This must be set competitive with other executive salaries in the market.

Pay equity

Pay equity refers to establishing fairness of pay. It is based on the equity theory which says that the compensation structure should be based on the input or the values add brought in by the executive. The executive comes with certain level of education and experience and receives salary and benefits equivalent to what they bring in.

If the employees find that their inputs are far greater when compared to peers, but their pay is less, they may feel unfairly compensated. Executives usually compare their pay with similar employees of other firms and if they are paid up to the same level, then they will feel happy or else they will look for a change in their job.

To examine the fairness in executive pay, several factors must be taken into considerations:

· Incentive should not be unethical, which means it should not be an influence of stock options.

· Pay should fit in the company’s strategy.

Executive bonuses

This is the variable pay based on the performance. This should be used to motivate people by giving the correct hike based on the performance and not on personal concerns.

Long-term incentives

These have become the important rewards for the executives and may constitute one half of total executive compensation. The common long-term incentive is the stock option. Executives can make a profit by selling

the shares whenever they are in need of liquid money. Since they are highly valuable and volatile, companies should exercise a lot of caution while allotting stock options to its employees.

Ethical concerns with executive compensation

To establish fairness of executive pay, several factors must be assessed. First, the executive pay package should be made responsible to shareholders, which means that it is not so high that it eats into the company profits or encourages unethical influence of stock prices. Second, pay packages must be competitive with those of other similar organisations, so that it helps to recruit, reward and retain executives. If a pay package is not competitive, there may be motivation problems which can lead to high turnover of executives. Third, executive pay should be aligned with the company’s strategy so that it encourages the overall success and growth of the company. This is particularly relevant with regard to short-term bonuses and long-term incentives, which can be used to steer the performance of the executive and the organisation. Finally, compensation for executives must be in compliance with the regulations followed by each country/state. There are a number of laws regarding retirement plans, stock options and so on which need to be abided by.

The main issue in the executive compensation is the ethical concern which is usually not taken into consideration. One main concern is the high level pay for executives can lure them to make business decisions that would benefit themselves rather than the organisation. The second concern with the ethics is some of the top executives who receive stock options as incentive might mislead the public about the financial health of the company only to push the stock prices up.

Self Assessment Questions

13. The ______________ theory emphasises on pay equity.

14. The common long term incentive in executive compensation is _______________.

15. Equity theory which indicates that the person what ever he brings as ___________ and what he receives as _________.

Activity 3:

Learn about the disclosure rules to be followed with respect to executive compensation packages

Hint: www.thefreelibrary.com/Disclosure+rules+to+build+an+effective+executive+compensation+strategy-a0210724248.

11.7 Different Criteria of Executive Compensation

Many issues are present in designing executive compensation. There are a lot of factors to be taken into account to ensure an optimum compensation package for executives. In this section, some of the important criteria are elaborated.

Strategy criterion

This refers to the correlation between the organisational strategy and the performance of its executives. The difficult work is to come out with a model which balances between organisational strategies and employee performance. One of the biggest expenses for an organisation could be the raising cost of employee compensation. On the other side, it cannot be neglected because the employee’s performance is directly related to compensation. Therefore, some of the important steps to be taken into account are:

· Creating incentives based on the product life cycle.

· Relating compensation to organisational strategies.

· Following a simple compensation strategy.

Role criterion

Hierarchical positions and organisational roles have a contributing effect on executive compensation design. Executives act as figureheads, and hence they should be compensated more than others in the lower rungs. However, organisations are now experimenting with structures to respond to the changing environment. It may be essential at times to sacrifice the traditional hierarchical structure. In such cases, executive compensation may not be aligned with the figurehead roles.

Sometimes the pay is based on functional aspects and not on the role or position. For example, pilots are not paid a high compensation package for their position, but for their functional aspects. Therefore, the roles and responsibilities of the job is an important aspect in deciding the executive compensation.

Behaviour criterion

The actions and the processes followed by executives while performing their jobs reveal their behaviour. This criterion is associated with the monitoring mechanism, and executives usually try and do a subjective analysis of the business decisions. Hence executive compensation based on behaviour criterion is quite sensible. However, executive behaviour is difficult to measure and all the aspects of the observed behaviour cannot be expected to meet a specific outcome. Hence, behaviour criterion has not received much attention from the corporate world.

Size

There is a general opinion that the size of an organisation plays the most influencing role while designing executive compensation, while on the contrary, it is not. It is the performance of the organisation which is the most important criterion which influences executive pay package.

Market

The marginal productivity theory of Roberts (1956) argues that a market forces, that is, supply and demand for executive talent determine executive pay. This theory considers the services of executives like any other input for running a business operation. The theory argues that the value of the input (executive compensation) is determined by the intersection of supply and demand in the labour market.

Peer compensation

The social comparison theory (O’Reilly et al. 1988) assumes that the compensation of selected peers plays a role in designing executive pay. Often board members of an organisation consider themselves as a referral point in their executive pay recommendations.

Self Assessment Questions

16. The main challenged faced in role criterion is peer comparison. (True/False)

17. Behavior criterion is associated with _________ mechanism.

18. The ____________ theory suggests that the compensation of selected peers may play a role in setting executive pay.

11.8 Summary

Executive compensation is one of the most interesting topics in the subject of compensation benefits. Executive compensation refers to the remuneration package offered to the top executives in the company which includes salary, bonus benefits and so on. The top level executives include chief executive officers (CEOs), chief financial officers (CFOs), vice presidents, occasionally directors, and other upper level managers. The executive pay components include base salary, bonuses, income protection guarantees, incentives such as stock option, severance package, signing bonus and perquisites.

Executive compensation design has direct relevance to the achievement of strategic and business objectives of the organisation. Optimising executive compensation cost and at the same time, keeping executives satisfied so that they can continue with the organisation, is the most important challenge for organisations, which are now riddled with competition.

The usual components of executive compensation are base pay and variables (incentive pay). Base pay is fixed and usually remains more or less the same across organisations. Variables and incentive plans are performance aligned, which organisations design keeping in view the strategic fit. Hence, it differs from organisation to organisation. HR managers design variables and incentive plans, relating it to the work performed by executives, the business results, or the overall strategy of the organisation by benchmarking the performance of the executives. Various short-term and long-term incentives are innovatively selected to ensure that executives continue with the organisation and perform to their best. Although stock option plans are often chosen as the best alternative, due to the difficulty in its valuation, organisations in general and executives in particular do not like to link it to the performance incentive plan. Various other innovative deferral compensation plans such as loyalty bonuses, pensions, and non-monetary benefits are chosen keeping in view the cost efficiency and executives’ satisfaction and performance. In a competitive industry, we also have examples of high executive compensation, which can go up to as much as 500 times a worker’s pay. Designing executive compensation requires knowledge about strategy and business issues, performance management aspects, market rate, and appropriate selection of criteria.

Q-2-3.9 Productivity Linked Employee Benefits

Now that we have understood the relationship between economics, labour markets and employee benefits, we will not learn about the concept productivity linked employee benefits. The three major drivers of the changing labour market scenario in India and other developing countries are technology, structural changes in the economy and pressures of competition. Countries like U.S.A could relate wages to productivity and rationalise the economics of organisations. Now, they are able to separate labour cost more scientifically from the total cost of production and logically keep control to remain globally competitive. In relatively labour intensive production processes, the pricing of labour based on productivity and performance is not so easy. The payment of wages from the welfare perspective is not only irrational but also forbidden.

Traditionally, productivity was considered as an input-output relational measurement. Traditional views attribute productivity to labour efficiency as output quantification can immediately be related to labour efficiency. But, this hypothesis seems to suffer from a major drawback, as many organisations, in spite of achieving high labour efficiency suffer from overall dysfunction and become sick.

To any organisation team effort is very important. Most of the organisations operate on team efforts by allocating different functional areas to different departments. Hence, a fall in a single functional area can affect the effectiveness of the other functional areas which may ultimately affect corporate efficiency.

Within the range of input-output relationship, the concept of input has widely changed under the current circumstances. Inputs are no longer detained to the direct materials used for production, but also include supportive functions in a more abstract form. In the present day, organisations consider knowledge and ideas also as part of inputs. For example: the production section in an organisation actually transforms physical inputs to outputs. Though other functional departments are not engaged in direct material transformation, they provide supportive inputs to production department for efficient functioning.

In 1982, productivity consciousness gained worldwide momentum with the declaration of the International year of productivity. Renowned economists, Smith, Ricardo and Mill expressed the concept of productivity in the form of the law of diminishing returns of all resources. But in the nineteenth century, Taylor’s theory “Task Study” came up with a slogan – human worth can be made infinitely more productive not by working harder but by working smarter. [4]In India, the productivity movement and consciousness gained momentum with the establishment of the National Productivity Council (NPC) in 1958.

When we look back at the history, it is found that the productivity concept originally emerged during the post war period.

Productivity

From an economic perspective, productivity refers to the yield from:

· Each factor of production like land, labour, capital and organisation.

· Each input like raw materials, fuel, time and knowledge.

· Overall yield of the joint factors and resources enumerated above, in combination.

There is a difference between production and productivity. Production refers to the process of transformation of raw materials and other inputs into finished goods or services. But productivity denotes a generation of surplus. When we define the term productivity in terms of input-output relationship, we can say that while production is transforming inputs into output by adding values, productivity is aimed at getting higher output over a given input. Therefore, excess output is equal to generation of surplus.

The ultimate goal for overall corporate efficiency is the functional efficiency and sub systems of all the other factors of production. Productivity depends on the efficiency of all the factors of production, instead of being solely dependent on the efficiency of labour. It is:

Production = value addition to new materials

Productivity = efficiency of production

= f(surplus efficiency of all points)

= f(men, materials, management)

There are six important factors that affect productivity in an organisation. These factors are as follows:

· Nature and quality of raw materials.

· Plants and equipment employed.

· Efficiency of plant and equipment.

· Basic nature of process employed.

· Volume continuity and uniformity of production.

· Utilisation of manpower.

Productivity measurement

Productivity measurement is left to ratio analysis. Let us illustrate this with an example.

Example: A company manufactures 10,000 mobile phones in a year. The selling price of each mobile phone is Rs 25,000. The company spends Rs 5,000 per mobile phone in material inputs and 1,00,000 man-hours to manufacture the mobile phones. Supposing we compute the following productivity ratios from the above problem:

· Output/labour ratio.

· Output value/labour ratio.

· Value added/labour ratio.

Solution

· Output/labour ratio (in terms of man-hours).

= 10,000 mobile phones/1,00,000 man-hours

= 0.1 mobile phones per man hour

· Output value/labour ratio (10,000 desktops × 25,000 per desktop)/100,000.

Man-hours = 2,500 per man-hour

· Value added/labour ratio is computed by first computing the value added which is = (output value-material value)

= {(10,000 × 25,000)-(10,000 × 5000)}

= 20,00,000

So value added/labour (in man-hours)

= 20,00,000/1,00,000= Rs 20 per man-hour

This approach to productivity measurement by linking it straight to wages will never benefit organisations nor will it benefit employees in the long run.

Omani factor model: This model gives a composite productivity index for all input and output costs of products[5]. While input costs are taken for all, output costs are decided on average marginal costs (AMC) method. Input costs are:

· Raw material costs.

· Manpower costs.

· Capital costs that is depreciation, interest, stock investment and so on.

· Indirect production costs.

· Cost of utilities.

Assuming we have three products X, Y and Z, the output costs using AMC method are:

Aggregate output= Output X + Output Y X (AMC of Y)/AMC of X+ Output Z X (AMC of Z)/ AMC of X

Where AMC percentage of X = {(Total input cost of X)/(Total output costs of X)} ×100

Productivity= Aggregate output/ Input costs

Surrogate model: This model is based on the qualitative factors to measure productivity. Factors such as the satisfaction of investors, employees, customers and suppliers are considered in qualitative terms[6]. The quantification of these qualitative terms is done as under:

Investors’ satisfaction (Si) = Net profit/total investment

Employee’s satisfaction (Se) = Total value added/total number of man-hours

Customers satisfaction (Sc) = Total sales revenue/total number of customers

Suppliers satisfaction (Ss) = Total purchases/total number of suppliers

The composite productivity index, therefore, is:

A.Si+B.Se+C.Sc+D.Ss

A, B, C and D are constants which indicate the relative weightage of the four parameters.

Employee benefits and productivity

Generally, it is believed that there is a link between wages and organisational productivity. But it is not proved that linking labour productivity to wages helps the organisation to derive cost savings and simultaneously increases labour motivation, performance and productivity.

First, it is very important to measure labour productivity and determine wages across the organisation and then understand the relationship between the rate of growth of productivity and the rate of growth of wages at the national and international level.

The actual level of output in each organisation is measured by dividing the total revenues received by the unit prices. Labour productivity can be measured by dividing the output by the number of hours worked by the employees in the organisation. Since revenue per employee and output per employee are not linked, they can be different.

It is assumed that when the labour output increases, the organisation’s revenue will increase because the employee’s enhanced contribution to output will generate additional revenues for the firm. Logically, employees should also get increased wages as the productivity is linked to wages.

If the productivity increases at the national level, the employees will be drawn from other countries. When output increases in an organisation, it should lower the prices in order to sell. When output increases in the nation as a whole, all workers will have higher incomes and those incomes may be used to purchase the increased output. Hence, the increased output creates the increased demand to purchase that output. Prices need not fall. But, if the prices do fall, the real income of all workers will increase. That is, workers will be able to buy more goods and services with their income. Hence economy wide increase in productivity could cause an increase in the welfare of the employees.

Q-3-Developing Pay Structure

From the previous section we came to know about establishing external equity. In this section let us discuss how we can develop the pay structures of the employees and why is it necessary to develop a proper pay structure.

Pay structure is the grouping of pay grades or pay bands.  There can be more than one pay structure in a compensation plan.  For instance, there may be one pay structure for service and maintenance positions, one for sales positions and one for managerial positions.  Or, the organisation may have just one structure for all positions. The process of developing the pay structure deals with internal and external analysis to assess the compensation package for the specific job profile. As discussed in the previous unit, job description provides in-depth knowledge about the job profile and its worth. For more information on job description, refer to unit 4– Compensation Management and Job Design.

Pay structure helps in analysing the employee’s role, value and status in the organisation. It also helps in the assessment of incentives.

If the organisation is paying very less to employees, then it may lose valuable employees. If the organisation is paying high, then it may be unwisely spending company resources.

The main goal of developing a pay structure is to manage and demonstrate an organisation’s compensation philosophy and to reflect and support the advancement of the company’s culture. An effective pay structure also helps to attract and retain the efficient employees.

An organisation’s pay structure is a visible demonstration of its compensation philosophy and plan. Pay structure is a tool, which is developed logically and communicated effectively to make the employees more motivated towards the job.

The following three factors have to be determined while developing a pay structure:

· The proper data for establishing the relative value of a particular job to the organisation.

· The proper pay range for a job with the defined value to the organisation.

· The value of each job position within the specified pay range.

Once the above factors are determined, pay structures can be developed through the following steps:

1. Group the jobs with those that have a similar value in the organisation.

2. Measure these groups to find out the number of pay ranges needed to group the jobs on the basis of their value to the organisation.

3. Create a salary range that has a minimum point, a mid-point and a maximum point for amounts allotted within the range and determine the pay for each job grouping.

An organisation’s compensation philosophy and pay strategy determines the approach that should be taken to allocate pay across job ranges. Factors to be considered are:

· Number of years of experience.

· Number of reporting staff members.

· Performance evaluation results.

· Hazardous working conditions.

· Undesirable shifts.

· Education and degrees.

· Professional certifications.

· Management opinions.

A successfully developed pay structure identifies career development in addition to promotion. It demonstrates and pays for the business results on which an organisation places value. An effective pay structure is worth the time and attention. It pays to get it right.

How an organisation structures its base salary program is basically a matter of organisational philosophy, although marketplace practices are very essential to consider in highly competitive situations. In structuring this base pay program, several options are available:

· Organisations can use a single rate structure in which the employees performing similar jobs will receive the same pay rate.

· Organisations can use a tenure based approach which focuses on from how long an employee has been employed in a particular job.

· Organisations can also use a combination of a tenure-based plan and a merit-based plan. For example usually employees begin their job at a fixed rate, and then progress to higher rates during their first year based on the number of years spent in the job, then any additional pay increase is awarded only on the basis of performance.

· Organisations can use a pay system based on productivity. An example for this would be an employee who is paid only a sales commission.

· An increasingly popular option is some form of base pay with an incentive opportunity, either based on individual, team, unit, or company performance.

Most of the organisations combine elements of these approaches to create their own formal program. The most common traditional pay structure involves grouping similar jobs into pay grades and assigning a salary range with a minimum, a midpoint, and a maximum as discussed earlier.

Q-4-Management expert, Henry Mintzberg, argued that it's really hard to get strategy right. To help us think about it in more depth, he developed his 5 Ps of Strategy – five different definitions of (or approaches to) developing strategy.

About the 5 Ps

Mintzberg first wrote about the 5 Ps of Strategy in 1987. Each of the 5 Ps is a different approach to strategy. They are:

1. Plan.2. Ploy.3. Pattern.4. Position.5. Perspective.

By understanding each P, you can develop a robust business strategy that takes full advantage of your organization's strengths and capabilities.

In this article, we'll explore the 5 Ps in more detail, and we'll look at tools that you can use in each area.

1. Strategy as a Plan

Planning is something that many managers are happy with, and it's something that comes naturally to us. As such, this is the default, automatic approach that we adopt – brainstorming options and planning how to deliver them.

This is fine, and planning is an essential part of the strategy formulation process.

Our articles on PEST Analysis, SWOT Analysis and Brainstorming help you think about and identify opportunities; the article on practical business planning looks at the planning process in more detail; and our sections on change management and project management teach the skills you need to deliver the strategic plan in detail.

The problem with planning, however, is that it's not enough on its own. This is where the other four Ps come into play.

2. Strategy as Ploy

Mintzberg says that getting the better of competitors, by plotting to disrupt, dissuade, discourage, or otherwise influence them, can be part of a strategy. This is where strategy can be a ploy, as well as a plan.

For example, a grocery chain might threaten to expand a store, so that a competitor doesn't move into the same area; or a telecommunications company might buy up patents that a competitor could potentially use to launch a rival product.

Here, techniques and tools such as the Futures Wheel, Impact Analysis and Scenario Analysis can help you explore the possible future scenarios in which competition will occur. Our article on Game Theory then gives you powerful tools for mapping out how the competitive "game" is likely to unfold, so that you can set yourself up to win it.

3. Strategy as Pattern

Strategic plans and ploys are both deliberate exercises. Sometimes, however, strategy emerges from past organizational behavior. Rather than being an intentional choice, a consistent and successful way of doing business can develop into a strategy.

For instance, imagine a manager who makes decisions that further enhance an already highly responsive customer support process. Despite not deliberately choosing to build a strategic advantage, his pattern of actions nevertheless creates one.

To use this element of the 5 Ps, take note of the patterns you see in your team and organization. Then, ask yourself whether these patterns have become an implicit part of your strategy; and think about the impact these patterns should have on how you approach strategic planning.

Tools such as USP Analysis and Core Competence Analysis can help you with this. A related tool, VRIO Analysis, can help you explore resources and assets (rather than patterns) that you should focus on when thinking about strategy.

4. Strategy as Position

"Position" is another way to define strategy - that is, how you decide to position yourself in the marketplace. In this way, strategy helps you explore the fit between your organization and your environment, and it helps you develop a sustainable competitive advantage.

For example, your strategy might include developing a niche product to avoid competition, or choosing to position yourself amongst a variety of competitors, while looking for ways to differentiate your services.

When you think about your strategic position, it helps to understand your organization's "bigger picture" in relation to external factors. To do this, use PEST Analysis, Porter's Diamond, and Porter's Five Forces to analyze your environment - these tools will show where you have a strong position, and where you may have issues.

As with "Strategy as a Pattern," Core Competence Analysis, USP Analysis, and VRIO Analysis can help you craft a successful competitive position. You can also use SWOT Analysis to identify what you do well, and to uncover opportunities.

Note:There can be a lot of overlap between "Strategy as Position" and other elements of the 5 Ps. For instance, you can also achieve a desired position through planning, and by using a ploy. Don't worry about these overlaps - just get as much value as you can from the different approaches.

5. Strategy as Perspective

The choices an organization makes about its strategy rely heavily on its culture – just as patterns of behavior can emerge as strategy, patterns of thinking will shape an organization's perspective, and the things that it is able to do well.

For instance, an organization that encourages risk-taking and innovation from employees might focus on coming up with innovative products as the main thrust behind its strategy. By contrast, an organization that emphasizes the reliable processing of data may follow a strategy of offering these services to other organizations under outsourcing arrangements.

To get an insight into your organization's perspective, use cultural analysis tools like the Cultural Web, Deal and Kennedy's Cultural Model, and the Congruence Model.

Using the 5 Ps

Instead of trying to use the 5 Ps as a process to follow while developing strategy, think of them as a variety of viewpoints that you should consider while developing a robust and successful strategy.

As such, there are three points in the strategic planning process where it's particularly helpful to use the 5 Ps:

1. When you're gathering information and conducting the analysis needed for strategy development, as a way of ensuring that you've considered everything relevant.

2. When you've come up with initial ideas, as a way of testing that that they're realistic, practical and robust.

3. As a final check on the strategy that you've developed, to flush out inconsistencies and things that may not have been fully considered.

Using Mintzberg's 5 Ps at these points will highlight problems that would otherwise undermine the implementation of your strategy.

After all, it's much better to identify these problems at the planning stage than it is to find out about them after you've spent several years – and millions of dollars – implementing a plan that was flawed from the start.

Key Points

The 5 Ps of Strategy were created by Henry Mintzberg in 1987. Each of the 5 Ps stands for a different approach to strategy:

1. Plan.2. Ploy.3. Pattern.4. Position.5. Perspective.

As a Plan, strategy needs to be developed in advance and with purpose. As a Ploy, strategy is a means of outsmarting the competition.

With strategy as a Pattern, we learn to appreciate that what was successful in the past can lead to success in the future.

With Position, strategy is about how the organization relates to its competitive environment, and what it can do to make its products unique in the marketplace.

Perspective emphasizes the substantial influence that organizational culture and collective thinking can have on strategic decision making within a company.

Understanding and using each element helps you develop a robust, practical and achievable business strategy.

Q-5-Introduction:Employee Satisfaction:The Impact and Cost of Dissatisfaction: It ismore common for companies to think in terms ofcustomer satisfaction. It is not as common fororganisations to see the linkage betweenemployee satisfaction and customer satisfaction.Research and experience establish a strongcorrelation between employee satisfaction andprofitability. Employees have direct and indirect impacton levels of service and quality. Service and quality affect customersatisfaction and retention. Customer satisfaction and retentionsignificantly influence profitability.Employee-Profit Paradigm:The above model illustrates the employee-profitconnection by showing the direct and indirectrelationship between employee satisfaction,quality, customer satisfaction, and profitability.Employee satisfaction plays an essential role inshaping company profits. Federal Express,Southwest Airlines, Banc One, British Airways,Taco Bell, Ritz Carlton, USAA Insurance andAmerican Express are examples of companiesthat subscribe to this philosophy.Facets of Dissatisfaction: Turnover

Absenteeism Poor Service/Quality Limited interest in Career Lowered Productivity Increased Costs Lack of Discretionary EffortHow to Approach the Issue of EmployeeSatisfaction: Calculate the real cost of employee turnover. Identify what you are doing well and whatneeds improvement. Determine what you can influence and whatyou cannot change. Quantify the financial impact of possiblesolutions. Implement solutions and measure the results Diagnose before PrescribingActions designed to increase employeesatisfaction and reduce turnover must be basedon factual information. This data can be gatheredin a variety of ways. Observe employee behavior Interview employees Benchmark other companiesA variety of methods can be used to measuresatisfaction levels among employees. The aboveareas represent broad categories of employeesatisfaction. The largest survey of workers in theUnited States was administered by the workinstitute of America. The findings from thisresearch reveal that salary and wage do not rankas high in importance as most people wouldcommonly think. In fact the top ten "reasonsconsidered very important in deciding to takecurrent job,” included: Open Communication Effect on Family/Personal Life Nature of Work Management Quality Supervisor Control over Work Content Gain New Skills Job Security Co-Worker Quality Job LocationCompensation:Compensation of employees is the totalremuneration, in cash or in kind, payable by anenterprise to an employee in return for workdone by the latter during the accounting period.Compensation is payment to an employee inreturn for their contribution to the organisation,that is, for doing their job. The most commonforms of compensation are wages, salaries andtips.

Organisations usually associatecompensation/pay ranges with job descriptionsin the organisation. The ranges include theminimum and the maximum amount of moneythat can be earned per year in that role.Compensation is a systematic approach toproviding monetary value to employees inexchange for work performed. Compensationmay achieve several purposes assisting inrecruitment, job performance, and job81Vishwakarma Institute of Management, Pune Vishwakarma Business Review,July 2010satisfaction. Compensation the methods andpractices of maintaining balance betweeninterests of operating the company within thefiscal budget and attracting, developing,retaining, and rewarding high quality staffthrough wages and salaries which arecompetitive with the prevailing rates for similaremployment in the labor markets.Employee Motivation:Motivation is nothing but an effort by themanagers to help people focus their minds andcapabilities on doing their work as effectivelyand efficiently as possible. Trust is another keyto motivate people to perform at their best.Effective interpersonal communication alsohelps to develop an environment. A trulymotivating environment is one where employeesfeel that their opinions are valued and where theycan experience a sense of belongingness.In today's complex business climate employeesnot only want appreciation for their work butalso want to be recognized as people and not justworkers. Today companies are adopting a varietyof programs to achieve goals together with theiremployee’s satisfaction. These employeeincentive programs are not just limited to salespeople but involve all employees to help meetcorporate objectives. These employees includeeveryone in the chain from line workers to officepersonnel etc. These programs are framed toemployee morale and empower them so that theytake more personal responsibility and achievetheir self actualization goals. These employeeincentive programs are often conducted asemployee training programs.Review of Literature:Barber, Dunham, Formisano (2006) examinedthe attitudes of 110 employees of a financialservice organisation before and after theintroduction of a flexible benefit plan. A large,statistically significant increase in benefitsatisfaction was observed following

implementation, as was a smaller significantincrease in overall satisfaction. Employeeunderstanding of the benefit package alsoincreased significantly. No significantrelationships were found between demographiccharacteristics and responses to the flexible plan.Potential confounds due to the complexity of theintervention are discussed. Future research iscalled for to examine the processes throughwhich flexible benefits impact worker reactionsand to examine the impact of flexible benefits onbehavioral responses such as attraction andretention.Bergman & Jenter (2007) stated that the use ofequity-based compensation for rank-and-fileemployees is a puzzle. They analysed whetherthe popularity of option compensation may bedriven by employee optimism, and show thatoptimism by itself is insufficient to make optioncompensation optimal. They provided empiricalevidence that firms use broad-based optioncompensation when bloodedly rationalemployees are likely to be excessively optimisticabout company stock, and when employees arelikely to strictly prefer options over stock.Bowen and Lawler (1992) also made adistinction that it depends on the kind of servicethat is offered whether to empower frontlineemployees and to what extent. In a productionline context where low costs and high volumesare important, the tie to the customer istransaction-oriented, the tasks are routine andsimple, the environment predictable with fewsurprises, and the employees have low growthand social needs so, therefore, empowerment isnot necessary.Chen, Choi & Chi (2002) in their studyexamined how local employees of internationaljoint ventures (IJVs) perceived disparity betweentheir compensation and foreign expatriates'compensation from equity theory and socialjustice perspectives. Chinese locals perceivedless fairness when comparing their compensationwith expatriates' than when comparing it withother locals'. However, fairness vis-á-visexpatriates increased if the locals werecompensated higher than their peers in otherIJVs or endorsed ideological explanations forexpatriates' advantage. Furthermore, expatriates'interpersonal sensitivity toward locals reducedthe effect of disparity on perceived fairness.Finally, perceived compensation fairness wasrelated positively to compensation satisfactionbut negatively to intentions to quit.Cooper and McKenna (1987) found that the

equity theory would predict that a majorinfluence on pay level satisfaction iscomparisons of one’s pay relative to that ofreferent others. Since these comparisonsprobably most often involve the individual'slevel of pay relative to others, external82Vishwakarma Institute of Management, Pune Vishwakarma Business Review,July 2010comparisons should most strongly influence paylevel satisfactionCore, Guay & Larcker (2003) posited that stockand option compensation and the level ofmanagerial equity incentives are aspects ofcorporate governance that are especiallycontroversial to shareholders, institutionalactivists, and governmental regulators. Similartoo much of the corporate finance and corporategovernance literature, research on stock-basedcompensation and incentives has generated notonly useful insights, but also has produced manycontradictory findings. Not surprisingly, manyfundamental questions remain unanswered. Inthis article, the authors synthesize the broadliterature on equity-based compensation andexecutive incentives, and highlight topics thatseem especially appropriate for future research.Dyer and Theriault (1976) hypothesized thatperceived appropriateness of pay criteriainfluences pay satisfaction. It is expected that ina merit pay context employees who perceive payincreases to be based on criteria other thanperformance are also less likely to see the criteriaas appropriate. Therefore, lower satisfaction withpay raises should result.Folger and Konovsky (1989) stated thatpsychologically one would expect attitudes aboutthe performance appraisal process to beinfluential in forming judgments of pay raisesatisfaction because employees perceiveinadequate performance appraisals to beprocedurally unfair with respect to the process ofobtaining pay increasesGaynor and Gertler (1995) concluded thatcompensation arrangements with greater degreesof revenue sharing (capitation) dramaticallyreduce the agent’s effort; this result is supportiveof theoryarguing that firms adopt second-bestincentive structures in order to spread risk.Goodrich Jeanne, Paula M. Singer(2004) statedthat pay, benefits, perquisites, the workenvironment and the intrinsic rewards that itoffers, all need to be used to attract the executivea library needs and wants. Both libraryexecutives and libraries hiring new executives

need to be aware of the variety of compensationapproaches available to them.Money & Graham (1999) sales managers inevery country face a crucial question of whatfactors affect sales force performance and jobsatisfaction. Conventional wisdom in the UnitedSates suggests that money is the paramountmotivator of salespeople.Pfeffer& Langton (1993) using a large sample ofcollege and university faculty, they studied theeffects of wage inequality on satisfaction,productivity, and collaboration. Results depictedthat the greater the degree of wage dispersionwithin academic departments, the lower isindividual faculty members' satisfaction andresearch productivity and the less likely it is thatfaculty members will collaborate on research.The negative effects of wage dispersion onsatisfaction are reduced for people who are morecommitted (have longer tenure), in fields withmore developed scientific paradigms, and whensalaries are based more on experience andscholarly productivity, but they are greater forthose who earn comparatively less money. Wagedispersion has a smaller negative effect onsatisfaction in private colleges and universities inwhich salaries are less likely to be known. Theresults suggested that one's position in the salarystructure, the availability of information aboutwage inequality, and legitimate bases of rewardallocation all affect the extent to which wagedispersion produces adverse effects.Steven H. Appelbaum, Loring Mackenzie (1996)notes the attempts by many companies today toidentify innovative compensation strategies thatare directly linked to improving organisationalperformance observes that there are manyapproaches to incentive compensation such ascash bonuses, stock purchase and profit sharing.The study examines the individual and groupincentive concepts that reward performancebased on predetermined organisational goals andmetrics, several behavioral theories that can beassociated with reward and compensation, andconvergent and divergent views and conclusionsfrom the business community.Tremblay, Sire, Pelchat (1998) the purpose ofthis study was to examine the influence ofindividual characteristics and organisationaljustice on employee benefit satisfaction, and toexplore the role of flexible benefit plans. Thefindings depicted that while distributive andprocedural justice were useful in predictingbenefit satisfaction, the concept of processjustice had the greatest effect on satisfaction.

Among the variables, communication had thegreatest impact. The effect of flexibility,83Vishwakarma Institute of Management, Pune Vishwakarma Business Review,July 2010although significant, was ambiguous. Sociodemographic factors had a very limited effectwhen perceptual variables were introduced intothe equation. The paper also sets out thelimitations of the study and its practicalimplications, and makes some suggestions forfuture researchWieselhuber and Koeniginstr (2005) found thatcompensation systems are an essential tool tolink corporate goals such as customer orientationwith individual and organisational performance.While some authors demonstrate the positiveeffects of incorporating nonfinancial measuresinto the compensation system empirically,companies have encountered problems afterlinking pay to customer satisfaction. Theresearchers argued that reasons for this can beattributed to the measurement of customersatisfaction as well as to the missing linkbetween customer satisfaction and customerretention and profitability in these cases. Hence,there is a strong need for the development of aholistic reward and performance measurementmodel enabling an organisation to identify causeand-effect relationships when linking rewards tononfinancial performance measures.Objectives of the Study: To develop and standardise a measure toevaluate employee satisfaction towardscompensation. To develop and standardise a measure forevaluating employee motivation. To evaluate the relationship betweenemployee satisfaction and employeemotivation. To open new vistas of further research.Research Methodology:The study was exploratory in nature with surveymethod being used to complete the study. Thepopulation included frontline executives ofGwalior region. Purposive sampling techniquewas used to select the sample taking individualrespondents as the sampling elements. The studywas conducted on 150 respondents as a samplesize.Self-designed questionnaires were used forevaluating employee satisfaction withcompensation system and employee motivation.Data was collected on a likert type scale, where 1stands for minimum agreement and 5 stands for

maximum agreement. The data was analysedthrough following tools:- Item to total correlation was applied tocheck the internal consistency of thequestionnaires. The measures have standardized throughcomputation of reliability and validity. Linear Regression Test was applied toidentify the relationship between employeesatisfaction with compensation andemployee motivation.

Mr.Senthil is the HR Manager of First Source Pvt. Ltd. He found that many of the employeeshave been doing the same work for a long period of time. He decided to enrich some of their jobs. List some of the strategies which can be used by Mr.Senthil to enrich jobs in organisations.