Compensation Meaning, Definition, Features, Objectives, Components, Importance

Table of Contents:-

  • Meaning of Compensation
  • Definition of Compensation
  • Features of Compensation
  • Objectives of Compensation
  • Components of Compensation
  • Factors Influencing Compensation
  • Importance of Compensation

Meaning of Compensation

Compensation, or employee remuneration, is an employee’s payment in return for their contribution to the organization. Compensation is influential in an employee’s life, affecting their standard of living, societal status, motivation, loyalty, and productivity.

For the employer, employee compensation is significant due to its contribution to the cost of production. Moreover, many conflicts arise between employers and employees over wages or bonuses, such as strikes and lock-outs. Employee compensation is also a significant function in Human Resource Management. HR specialists face the challenge of establishing wages and wage differentials acceptable to employees and their leaders.

Historically, compensation systems have been based on:

  1. Pay for performance or
  2. Pay for responsibility (job description).

Each of these is centred around individual performance, fostering a competitive atmosphere among employees. In contrast, the TQM philosophy emphasizes flexibility, lateral communication, group effectiveness, and responsibility for an entire process, ultimately leading to customer satisfaction.

Compensation systems are designed with strategic goals and business objectives based on certain factors analyzed from job work and responsibilities. The components of a compensation system involve the following points:

  1. Job analysis,
  2. Salary structures and
  3. Pay structure.

Definition of Compensation

Gary Dessler states, “Compensation means all forms of pay or rewards going to employees and arising from their employment”.

Terry Leap states, “Compensation is a broad term about financial rewards received by persons through their employment relationship with an organisation”.

Cascio states, “Compensation includes direct cash payments, indirect payments in the form of employee benefits, and incentives to motivate employees to strive for higher levels of productivity.”

According to R. Wayne Mondy, “Compensation is the total of all rewards provided to employees in return for their services. The overall purposes of providing compensation are to attract, retain and motivate employees”.

Features of Compensation

Compensation should possess the following features to motivate individuals or teams to perform well and effectively:

Features of Compensation are listed below:

  1. Timeliness
  2. Flexibility
  3. Durability
  4. Visibility
  5. Cost Effectiveness
  6. Availability
  7. Performance Related
  8. Equity

1) Timeliness

The motivational impact of compensation diminishes when there is a delay between performance and reinforcement. Therefore, compensation should be provided promptly.

2) Flexibility

To be effective, the organization should compensate employees as frequently as possible. Flexible compensation, in terms of quantity and recipients, provides essential extrinsic motivation when given regularly.

3) Durability

Some forms of compensation endure longer than others. Intrinsic compensation, such as increased autonomy and accountability, lasts longer than extrinsic compensation, like pay raises.

4) Visibility

Management must ensure that compensation is visible throughout the organization to promote the compensation system. Visual compensation, such as committee assignments or job promotion, signals to employees that rewards are available, timely, and performance-based.

5) Cost Effectiveness

Compensation allocation incurs costs, so careful consideration is necessary to understand the payoffs and avoid excessive financial burden. Compensation should ideally be allocated at a relatively low cost.

6) Availability

For compensation to reinforce desired performance, it must be readily available. Inadequate compensation fails to serve as a reward. For example, unavailable desired salary increases may lead to negative consequences such as theft or falsifying records.

7) Performance Related

Compensation should be closely tied to performance. The more precise the connection between performance and compensation, the better it can motivate desired behaviour in employees.

8) Equity

Compensation must be perceived as fair. Employees often compare their compensation to that of others in similar positions. If performance varies, there should be justification for differences in compensation to avoid feelings of inequity. Employees may seek to align their performance with their compensation, thus enhancing overall effectiveness.

Objectives of Compensation

The objectives of compensation are as follows:

  1. Maintain Macroeconomic Stability
  2. Improves Employee Efficiency
  3. Maintains Industrial Peace
  4. Control Costs
  5. Comply with Legal Regulations
  6. Establishes Equity
  7. Provides Efficient Allocation of Labor

1) Maintain Macroeconomic Stability

Another objective of compensation is maintaining macroeconomic stability, which involves low inflation and high employment levels. For example, excessively high minimum wages could adversely affect employment levels.

2) Improves Employee Efficiency

Compensation is increasingly used to motivate employees to enhance their performance, effectively achieving organizational goals and objectives.

3) Maintains Industrial Peace

Fair and adequate compensation motivates employees, boosts morale, and improves union-management relations, promoting industrial peace.

4) Control Costs

A rational compensation system helps organizations obtain and retain workers at a fair salary while ensuring workers are neither overpaid nor underpaid.

5) Comply with Legal Regulations

A sound compensation system considers legal challenges imposed by governments, ensuring compliance with legal regulations.

6) Establishes Equity

An essential objective of compensation is to establish equity, achieved through income distribution by narrowing inequalities, increasing wages for the lowest-paid employees, protecting real wages (purchasing power), and ensuring equal pay for work of equal value.

7) Provides Efficient Allocation of Labor

Compensation efficiently allocates labour in the labour market, facilitating employee movement for net gains. This movement may involve geographical or job changes driven by financial incentives.

For example, workers may relocate to regions offering higher wages, improving their earning potential by acquiring new skills.

Components of Compensation

A compensation package consists of the total monetary compensation and employee benefits. While some employees tend to focus solely on their salary when considering their compensation, it is essential to note that the benefits offered by some companies can hold more excellent value than the salary itself. The typical components of a compensation package are as follows:

  1. Incentives
  2. Fringe Benefits/Perquisites
  3. Allowances
  4. Bonus
  5. Non-Monetary Benefits
  6. Wages and Salary

1) Incentives

Incentives, or payment by results, refer to workers’ monetary benefits to recognise their outstanding performance. These rewards are defined as variable compensations granted based on attaining specific desired outcomes. Unlike fixed wages and salaries, incentives typically differ from individual to individual and may also vary over time for the same individual.

Incentive systems play an essential role in organisational motivation and are instrumental in helping managers understand the driving forces within the organisation. These systems can either encourage or discourage employee and workgroup behaviour. A well-designed incentive system promotes employee productivity and creativity, cultivates loyalty among the most productive individuals, and fosters innovation.

2) Fringe Benefits/Perquisites

Fringe benefits, also known as employee benefits, perquisites, or perks, are various non-wage compensations provided to employees in addition to their regular wages or salaries. When an employee exchanges wages for some other form of benefit, this is generally referred to as a “salary sacrifice” arrangement. Employee benefits are available to all employees based on their membership in the organisation.

3) Allowances

An allowance is generally defined as a fixed quantity of money or other substance given regularly in addition to salary to meet specific requirements connected with the service rendered by the employee or as compensation for unusual circumstances of that service. There are generally three types of allowances for income tax; some are taxable, while others are fully or partially exempted.

Some well-known allowances include house rent, dearness allowance, daily allowance, travel allowance (in the case of shift allowance), outstation travel, etc. The concept of allowance is based on the cost of living index, where dearness allowance and house rent allowance are provided to compensate for the additional efforts required to fulfil one’s regular duties.

Additional allowances may be included in the basic compensation package, depending on the specific requirements and circumstances of the job. Some organisations pay high-risk allowances for extraordinary hazards in jobs such as those in the petroleum industry or forest firefighting. The quantum of most allowances is usually linked to the basic salary, as they are calculated as a percentage of the basic salary.

4) Bonus

One of the most popular compensation trends is using bonuses. The dictionary meaning of the word ‘bonus’ is ‘something to the good’, especially an extra dividend to the shareholders of a company or the distribution of profit made by the industry as a result of the joint contribution of capital and labour in a particular year. A bonus is no longer an ex-gratia payment. Payment of a bonus is extra and is not part of basic pay. It is defined as pay under the law and must not be gender biased. It is the industrial right of employees to be subject to industrial dispute.

Bonuses can be based on subjective ratings or objective goal attainment. In some organisations, bonus awards are shared by all employees if organisational goals are met, whereas, in others, the magnitude of the bonus is directly linked to the performance of each individual. Historically, bonus payments have played a pivotal role in the compensation packages of numerous manual workers, often related to productivity within manufacturing companies.

Examples of bonuses include:

i) Attendance bonus, e.g., for some workers in manufacturing.

ii) Profit-related bonus, e.g., in retail management.

iii) Performance bonus payments for high achievers.

iv) Work study-related bonus payments for manual workers in manufacturing or local authorities.

5) Non-monetary Benefits

Non-monetary benefits, or non-monetary compensation, are essential for recruiting highly skilled employees and maintaining a satisfied and efficient workforce. Some examples of non-monetary compensation include time off, flex-time, free or discounted parking, retirement matching, gym membership discounts, tuition assistance, mentoring programs and childcare. They are a customary part of agreements between employers and employees. Non-monetary benefits are typically provided to enhance employees’ quality of work life. Because money alone may not fully satisfy the basic needs of employees, non-monetary compensation proves beneficial and sometimes essential for employees.

6) Wages and Salary

“Wages” typically refer to the hourly rate paid to groups such as production and maintenance employees (“blue-collar workers”). The difference between a wage and a salary lies in how the hiring organisation calculates the employee’s monetary compensation. A company pays wages to an employee based on hours worked, at an agreed-upon rate for each hour worked or portion thereof, such as a quarter-hour. In contrast, a worker who receives salary-based compensation receives a specified monetary payment for carrying out the duties of a particular job, regardless of the number of hours worked.

Factors Influencing Compensation

Factors influencing compensation are as follows:

  1. Bargaining Power
  2. Condition of Product Market
  3. Cost of Living
  4. Government Policy
  5. Comparative Wages
  6. Productivity of Labor
  7. Ability to Pay
  8. Goodwill of the Company
  9. Job Requirements
  10. Demand and Supply

1) Bargaining Power

Wage rates also depend primarily on the relative bargaining power of trade unions or workers and employers. When labour unions are strong enough to compel employers, wages will be higher than in units where unions are weak.

2) Condition of Product Market

Wage levels are influenced by the competition prevailing in the market for the industry’s products. In a perfectly competitive market, wage levels may align with the value of the net additions made by workers to the total output. However, wage levels may not reach this level in industries or occupations with imperfect competition in the product market.

3) Cost of Living

The cost of living varies at different levels, from country to country and within the same country, such as between urban and rural areas, due to inflation. Thus, the cost of living may serve as the basis for adjusting compensation plans. For example, wages and salaries in industrially advanced countries are much higher than those in economically less developed countries.

4) Government Policy

Government intervention and regulation of wage rates become imperative when workers’ bargaining power is insufficient to ensure fair wages in all industries. Government intervention aims to establish minimum wage rates covering essential needs for a decent standard of living.

5) Comparative Wages

Wage levels are influenced by wages paid by other firms in the same market for similar work. Ensuring comparative wages enhances job satisfaction, overall productivity, and employee morale.

6) Productivity of Labor

The productivity of human resources is another market-related force affecting compensation management. High personnel productivity correlates with higher wage and salary rates, while low productivity leads to lower wages and salaries.

7) Ability to Pay

Wage rates are influenced by an industry or firm’s capacity to compensate workers. Companies that generate substantial profits can offer higher wage rates and provide more amenities to their employees than firms that earn marginal profits.

8) Goodwill of the Company

Some employers aim to establish themselves as good employers by offering higher wages to their workers, which helps attract qualified employees.

9) Job Requirements

Workers are compensated based on the specific requirements of their roles. Positions demanding advanced skills, increased responsibility, and greater risk naturally command higher wages than jobs with lower skill, responsibility, or risk levels.

10) Demand and Supply

The nature of demand and supply varies and operates at regional, national, and global levels, determining the compensation structure. The demand and supply of labour influence wage and salary fixation. A low wage may be set when the labour supply exceeds its demand, while a higher salary must be offered when the demand for labour exceeds the available supply, as seen in the case of skilled labour.

Importance of Compensation

The importance of compensation is as follows:

  1. Acts as a Source of Organisational Effectiveness
  2. Helps in Retaining Employees
  3. Maintains Organisational Harmony
  4. Motivates Employees for Better Performance
  5. Serves as a Medium between Organisation and Employees
  6. Stimulates Employee Involvement
  7. Encourages Healthy Competition and Collaboration
  8. Helps to Differentiate between Good and Poor Performers
  9. Helps in Attracting Talent
  10. Strengthens Organisational Competitiveness

1) Acts as a Source of Organisational Effectiveness

Organisational effectiveness can be obtained only from high-performing employees. High-performing employees can make all other resources perform positively. Remuneration is a well-documented and effective method of encouraging employees to perform excellently.

2) Helps in Retaining Employees

Retaining productive employees is essential for any business’s smooth functioning and success. Retaining employees saves companies money in training costs and contributes to maintaining an efficient and knowledgeable workforce. Health insurance and retirement packages are benefits that many employees desire from their employers, as they provide a sense of security and peace of mind. Companies that offer these benefits are more likely to retain their employees than those that do not offer such perks. One effective strategy to retain employees is by offering regular promotions. This approach boosts an employee’s base salary and empowers them to assume greater responsibilities within the workplace.

3) Maintains Organisational Harmony

Remuneration that is managed well can be a great source of organisational harmony, which is a fundamental requirement for fostering exceptional employee and organisational performance.

4) Motivates Employees for Better Performance

Remuneration is a dynamic tool. It creates opportunities to fulfil motivational needs and enhances the intensity of motivation. This means that employee motivation increases whenever they are suitably rewarded. Enhanced motivation leads to higher performance, subsequently leading to greater rewards.

5) Serves as a Medium between Organisation and Employees

Remuneration can perform the role of a medium as it brings the organisation and its employees together. Hence, effective remuneration management is essential for the organisation and its employees.

6) Stimulates Employee Involvement

Employee empowerment, involvement, participation and studies sufficiently establish that performance excellence can come from employee involvement. This involvement can be obtained by providing opportunities for employees to apply themselves in organisational management. Remuneration is one potential source that can be effectively utilised to create such avenues of engagement.

7) Encourages Healthy Competition and Collaboration

Remuneration can guide the organisation and its employees to perform at their best. Remuneration encourages collaboration and healthy competition among employees to perform well, leading to innovation in achieving remuneration goals.

8) Helps to Differentiate between Good and Poor Performers

The general performance profile of a typical organisation consists of a marginal percentage of low performers, high performers and the majority of average performers. The performance of average employees can be improved by rewarding high performers and depriving rewards from low-performing employees. This remuneration difference helps manage different types of performers differently and encourages moderate or low performers to become high performers.

9) Helps in Attracting Talent

The compensation packages that businesses offer employees play an essential role in the company’s ability to attract top talent as job candidates. Top-performing employees have a significant impact on the competitiveness and productivity of a business. The specific components of an attractive compensation package vary depending on the employees. A high base salary may attract a top job candidate who is young and single, while a job candidate with a family may consider a flexible work schedule extremely important. Therefore, recruiters should research a job candidate’s current or prior salary and benefits to understand what is essential to the candidate.

10) Strengthens Organisational Competitiveness

Organisational competitiveness comes from the sheer performance capacity of organisations. This capacity becomes particularly evident when organisations face crises. Consequently, any organisation aiming to enhance its competitiveness must implement an appropriate remuneration system.

Leave a Comment

Your email address will not be published. Required fields are marked *

Scroll to Top
Modes of Entry into International Business