Session 2

According to economic theory, wages are defined broadly as any economic compensation
paid by the employer to his laborers under some contract for the services rendered by them.
In its actual sense, which is prevalent in the practice, wages are paid to workers which
include basic wages and other allowances which are linked with the wages like dearness
allowances, etc.
Traditionally, in the absence of any bargaining power possessed by labourers, they did not
have any determination of wages paid to them. This has led to the development of several
theories of wages and each theories explain how wages are determined.

Economic Theories

1. Subsistence Theory by David Ricardo (1772-1823) :

 It was from Thomas R. Malthus's theory of population from which
Ricardo took his inspiration. David Ricardo translated Malthus's theory
into the subsistence theory of wages.
 According to this theory, wage tend to settle at the level sufficient to
maintain the worker and his family at minimum subsistence
  According to this theory, wages are determined by the cost of production
of labour or subsistence level. 
 If actual wages are higher than the subsistence level, then population will
increase leading to an increase in labour supply and lower wages.
 If on the other hand, the actual wages fall below the subsistence level,
population will decrease resulting in a decline in labour supply and rise in
wages
 Since there is a tendency for the wages to remain fixed at the subsistence
level, it is called as Iron Law of Wages

This theory suggests that,

Wage=Amount sufficient to meet the basic need

2. Wage Fund Theory (1818-1883)

 This theory was advocated by John Stuart Mill as a supplementary to the

subsistence theory propounded by David Ricardo.
 According to this theory, a fixed amount of wage fund is available to pay
the labours/employees and the level of wage depends on the number of
labours
  According to this theory, Wage rate is determined by the amount of
wages fund and the total number of labours.
 According to this theory, if the number of employees increases the wages
decreases, if the number of employees decreases the wage increases. An
increase in wage rate is possible only by an increase in wage fund or by a
reduction in the number of labourers.
  According to this theory, wages depend upon the demand and supply of
labour or as it is often expressed as proportion between population and
capital. 
 According to this theory, trade unions cannot raise wages for the labour
class. The efforts of trade unions to raise wages are futile. If they
succeeded in raising wages in one trade, it can only be at the expense of
another, since the wage fund is fixed, and the trade unions have no
control over population
 This theory suggests that,

Amount of fund allocated for wage payment

Wage= ---------------------------------------------------------
Number of employees to be paid

3. Marginal Productivity theory:

 The main regulators of wages are demand and supply of labours and
compensation
 The marginal product of labour in any industry is the amount by
which the output would be increased if one more man was employed
while the quantities of production in the industry remained
constant.In short, the cost of employing an additional labour should
result in good production

4. Surplus Value Theory (1818-1883)

 This was developed by Karl Marx, according to this theory, labor is an
article or commodity which can be purchased on payment of a price.
 The price of any product is determined by the labor time needed for
producing it, and not the period time spent. This helps the employer to
generate the surplus which could be utilized for other expenses.
  This theory thus advocates that a worker is to be paid according to the
average time required to produce it and not the actual time a labour spent
to do it

5. Bargaining Theory of Wages by John Davidson

 According to this theory Wages are determined by relative
bargaining power of workers or trade unions and of the employers
 The fixation of wages depends on the bargaining power of
workers/trade unions and employers. If workers are stronger in
bargaining process, then wages tends to be high. In case, employer
plays a stronger role, then wages tends to be low.

6. Purchasing power theory :

 Propagated by Lord J.M.Keynes, if wage rates are high, the
workers will have more purchasing power which will cause
increases in the demand for goods and services and the output
activity will tend to go up and demand for labour will be high.

7. Modern theories of wages:

Modern theories explain that wages are determined by law od demand and
supply of labour
Traditional theory did not consider the trade union and collective bargaining
in wage ndetermination, but they should have considered them for wage
determination

Behavioural theory

Equity Theory
• Equity can be Internal or external equities
• Internal equity refers to the pay differential between and among the
various skills and levels of responsibility.
• External equity refers to concerns regarding how wage levels for similar
skill levels in one firm compare with those in other firms in similar or the
same industry and location.

Adams’ equity theory of motivation says that to be motivated, individuals

need to perceive that the rewards they receive for their contributions are fair,
 and these rewards are similar to those received by their peers. If individuals
perceive that their rewards are not fair, they will feel distressed and try to
change things to create a sense of fairness.

2. Herzberg’s Motivation Theory – Two Factor Theory:

• Herzberg’s Motivation Theory model, or Two Factor Theory, argues that
there are two factors that an organization can adjust to influence
motivation in the workplace.
• These factors are
 Motivator factor: Which can encourage employees to work harder.
 Hygiene factors: These won’t encourage employees to work harder.
The presence of motivators causes employees to work harder.
The absence of hygiene factors will cause employees to work less hard

3. Expectancy theory
It suggests that motivation depends on individuals’ expectations about
their ability to perform tasks and receive the desired rewards. An
employer’s responsibility is to help employees meet their needs and at the
same time, attain organizational goals. Employers must try to find out
match between employees’ skills and abilities and the job demands.

Compensation Philosophy
 A compensation philosophy is simply a formal statement
documenting the company's position about employee
compensation. It explains the "why" behind employee pay and
creates a framework for consistency. Employers use their
compensation philosophy to attract, retain and motivate employees.
 Compensation philosophies are typically developed by the human
resources department in collaboration with the executive team. The
philosophy is based on many factors, including the company's
financial position, the size of the organization, the industry,
business objectives, market salary information, the level of
difficulty in finding qualified talent, and the unique circumstances
of the business
  The compensation philosophy should be reviewed periodically and
updated based on current factors affecting the business
 A well-designed compensation philosophy supports the
organization's strategic plan and initiatives, business goals,
competitive outlook, operating objectives, and compensation and
total reward strategies

Objective of Compensation Philosophy

 Identify or understand their's frequency of review in connection to
compensation philosophy (Covid salary example)
 Understand the organization's frequency of review in connection to
compensation philosophy – Private org, public org
 Understand the organization's pay programs and be transparent
 Retain key talent and reward high-performing employees
 Ensure equal pay for equal work, with allowable pay differences based on
factors not prohibited by law
 Compensation Philosophy should be able to withstand challenging
situations when they arise in organization and has to confront them.
(covid)

 They always give employees fair compensation according to their role, level, and
situation. “Amazon will always pay you fairly for the job you're going to do.

 Google operates under a pay for performance philosophy that rewards top

performers. which are usually awarded through equity refresh grants and cash
bonuses at year end

Compensation Strategy
 It is a or budget or employee plan for rewarding, developing and creating
employee’s compensation plan who are working in the organization
 It is through compensation strategy that the organization are reaching its
goals
 The compensation strategy should be based on premise that employee are
the ultimate source of value, compensation process should take of both
the employee and organization.
Characteristic of Compensation Strategy
• A compensation policy and process should align with the organization
strategy to enhance performance (should go hand in hand)
• Compensation strategy should attract, retain the high performers to meet
the organization objective
• Compensation strategy focuses on the established values of the
organization (Ex google compensation str is to attract employee with
innovativeness)
• Compensation strategy should meet the needs and expectation of the
employee both individually and in group
• Compensation strategy should be mix of both monetary and non-
monetary benefits
• Compensation strategy should comply with compensation policy,
organization strategy, statutory obligation and budget
How to have an effective Compensation Strategy:
 Budget allocation: salary percentage
 Salary audits: to see if the salary and wages are being paid fairly
 Non-Monetary benefit: to retain employees
 Performance management process: to reach the objective of the
organization
 Statutory obligation: to provide PF, Gratuity, bonus(8%to 20%)

Why Compensation Strategies are different?

 It differs from industry to industry: Service industry to manufacturing industry
 It differs from organization to organization : Example - Another
compensation strategy used by Apple Company is performance-based cash
incentive. The strategy has help Apple Company in attaining its goals, objectives as
well as attaining better financial performance as compared with its competitors
 Department to department
It is also differs Internal and external environment
 Internally through factors like work culture, infrastructures, technology,
raw material , number of employees available.
 External factors the competitor’s industry

Developing CS
  Assess total compensation implication:
 Map total compensation strategy
 Implement the strategy
 Reassess the strategy

Psychological contract.
HR professionals are familiar with contracts.  In almost every industry,
companies ask potential new employees to sign at least one form or another.  In
some cases, there are multiple types.  However, there is one contract that is not
signed:  the psychological contract.
 The concept of the psychological contract was originally developed
by Denise Rousseau
 Psychological contract refers to the relationship between an employer and
employee where there exit unwritten and mutual expectations
 Managing compensation is largely about managing expectation:
1.What employees expects from their employer in return for their
contribution is the expectations
2.What employer expects from their employee in return to the pay,
opportunities to work, and the skills?
 Psychological contract is a philosophy rather than formula or plan, it
considers the factors such as compassion, respects, trust and objectives
and moral.
 Psychological contract can be differentiated from other contract