A Full Guide to Compensation and

Benefits
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Posted by Erik van Vulpen

Compensation and benefits refer to the benefits a firm provides to its employees in
exchange for their labor. Compensation and benefits are thus a key part of Human
Resource Management. In this article, we will provide you with a full guide about
compensation and benefits. 

Contents

kWhat are compensation

a and benefits?
* J d v
Why are compensation and benefits important?
Compensation and benefits and employee motivation
How do HR Departments calculate compensation and benefits?
3 Models to Explain Compensation and Benefits
Compensation and benefits package example
Frequently Asked Questions

What are compensation and benefits?

When you receive a job offer, the first thing you look at is the salary. Whether the recruiter
lists the wage as an hourly, weekly, monthly, or hourly rate, candidates see it as the most
critical part of any job offer. Typically, when employees think about compensation, the
salary is what they think of. But, for many employees (especially senior employees)
compensation is far more than just the regular paycheck.

Benefits cover indirect pay. This can be health insurance, stock options, or any myriad of
things offered to employees. All of these things are critical in any job offer. Two jobs that
offer identical salaries may vary wildly in the benefits category, making one a better
financial proposition than the other.

Overtime pay, stock options, 401k matches, pension plans, days off, and even free lunches
make up an essential part of the compensation and benefits package. 

Some benefits are country-specific. In the United States, health insurance makes up a key
component of benefits. Who your employer is, determines your health care options – even
down to which doctors you can see and which medications are covered.

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In Europe, there is often a focus on more social benefits, including parental leave,
severance pay, and termination notice. In countries like France and Finland, it is not
uncommon for employers to pay for restaurant vouchers that cover part of the
employee’s lunch. 

Cultural differences in benefits: In France, employees get a restaurant voucher for

every workday if their company doesn’t have a canteen.

Most often, compensation and benefits (commonly referred to as comp & benefits) fall
under the responsibility of the Human Resources department. In a small company, an HR
generalist would handle all aspects of this process, while in a large company, there would
be dedicated departments to manage these.

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Why are compensation and benefits
important?
Compensation and benefits are important for two reasons.

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First, people won’t work for you without pay. And unless you’re a non-profit organization,
it’s illegal to ask them to work for you for free. There is a social contract between the
employer and employee, where the employee puts in the work and the employer rewards
this. Compensation and benefits are an important part of that equation.

Other things play a role too – and we’ll discuss them later – but what the employee
receives is central. In addition to salary, benefits remain a crucial motivator for job
candidates.

Second, as of June 2019, benefits make up 31.4 percent of the cost of employing
someone. It is a significant expense with a clear goal so it’s not something businesses can

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overlook. This is why paying careful attention to a fair compensation and benefits
structure is so important.

But, how does compensation motivate employees and do increases make a difference?

Compensation and benefits and employee

motivation
Glassdoor found that a 10 percent increase in base pay resulted in a 1.5 percent increase
in the chance that the employee would stay at the company for their next role, rather than
moving on. While their findings were statistically significant and turnover is expensive, it’s
probably not enough to convince a boss to give someone a 10 percent raise. 

This same research found that a higher company rating on Glassdoor resulted in a four
percent increase in the chance that someone would stay at the company. Salary is clearly
important, but there is something other than money going on.

A Payscale study gives some insight into the influence of salary. They found a strong
correlation between pay and engagement (and engagement profoundly influences
retention), but what was stronger is pay clarity. When employees understood that their
compensation was fair, it increased their engagement.

Procedural and distributive fairness

Compensation fairness consists out of two elements: procedural fairness and distributive
fairness.

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1. Distributive fairness refers to the perceived fairness of the amount of

compensation the employee receives.

2. Procedural fairness refers to the perceived fairness of the means used to

determine those amounts.

Research shows that both distributive fairness and procedural fairness lead to higher
employee retention.

However, when it comes to employee engagement (or motivation), procedural fairness

seems more important than distributive fairness. A study in the UK showed a link between
procedural fairness and engagement. Another study among Chinese compulsory school
teachers showed that procedural fairness, not distributive fairness, predicted employee
motivation. 

In other words, it’s not so much about money as it is about communication and honesty.
Traditionally, many companies keep salary information confidential. Some managers even
punish employees for sharing their salaries with co-workers, even though the National
Labor Relations Act protects employees’ rights to discuss their working conditions,
including salary. Secrecy can backfire, though, as employees are concerned that their pay
is not fair. 

When an employee clearly understands that their compensation is commensurate with

ktheir skills, positionain the company,*and broader jobJmarket, they are more
d likely to be v
engaged in their work.

Benefits and motivation

Salary is only a part of compensation, though. Other benefits, such as pensions, 401ks,
and stock options, also help increase employee retention. Many of these benefits require
a period before the employee is vested. That is, you don’t receive the money or benefit
from these forms of compensation until you’ve worked a minimum amount of time. If you
quit before this date, you give up the stock or 401k match or other benefits.

Researchers at the University of Pennsylvania found that delayed compensation did

decrease turnover overall, but it also resulted in employees quitting just after they did
vest. In other words, employees are acting strategically when choosing to leave their jobs.
They wish to move on but also want to maximize their compensation.

The Society for Human Resource Management (SHRM) found that 62 percent of U.S.
employees rated their health care benefits as very important to them, meaning that this is
an area that companies can focus on to increase engagement and retention. 

The same SHRM study also found that indirect compensation benefits also strongly
influenced employee happiness. Things such as paid time off (63 percent said it was very
important), flexibility (53 percent), and family-friendly benefits (35 percent) strongly
influenced employee satisfaction with their jobs. The traditional money-based programs,
such as retirement benefits, were also important. Still, at 48 percent saying retirement
benefits were important, you can see how flexibility and vacation may cost you less and
increase happiness overall.

Of course, because compensation and benefits can vary across companies and
geographic regions, it’s important to benchmark your programs to ensure you’re
maximizing the benefits from your programs.

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How do HR Departments calculate
compensation and benefits?
While governments set the floor for pay, known as a minimum wage, businesses are
generally free to set their own wages. However, you’d be hard-pressed to hire an
accountant for minimum wage. Instead, you’ll need to pay a market rate.

A market-rate can also be defined as a “going rate” and is the amount people are willing to
pay for a particular good or service. Employees are offering their services and fall under
this definition. There are market rates for each position, but because people are rarely
transparent about salaries, this can be difficult to ascertain.

A compensation specialist will use salary surveys to help her determine a market rate. A
salary survey asks many businesses to share their compensation data for positions. The
data is then anonymized and sold back to businesses. In this way, a company can
determine that the average rate for a junior accountant is $X, while the average rate for a
marketing manager is $Y.

Because positions vary from company to company, you cannot just look at the salary
survey and base all your salaries on the average salary for someone with that title. A
marketing manager at a Fortune 500 company will have a very different job description
than a marketing manager at a 25-person business.

Compensation managers will determine not only an ideal salary for a position but a salary
range. Because candidates vary wildly, it doesn’t always make sense to pay different
people the same amount. One person may have more experience and better skills than
another and deserves a higher salary. Each range has a mid-point, which you may hear as
a compa-ratio. If you have a compa-ratio of 100 percent, that means you are at the
midpoint of the salary range.

Determining where someone fits within that salary range can also be complicated.
kCompensation managers
a often use*statistical tools, such
J as regression danalysis, to v
establish a proper salary position. The variables that the regression use can include

Highest degree earned (and type and degree area)

Years of experience

Tenure with the company

Position tenure

Current salary

Full-time equivalent status

Exempt vs. non-exempt status

Grade level or salary band classification

Employee location (if you have multiple locations)

Job performance ratings

In addition to salaries, stocks, retirement benefits, health insurance, and any other benefit
are included in compensation figures. 

3 Models to explain compensation and

benefits
While compensation and benefits is a flat model to explain differences in pay, there are
two scientific models that enable us to understand compensation and benefits in a better
way.

Compensation and benefits vs. total rewards

As discussed, compensation and benefits are not the only aspects of employee happiness,
engagement, and retention. The Total Rewards Model demonstrates the interplay
between the organization and compensation. 

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The Total Rewards Model, coined by WorldatWork, proposes that total rewards are made
up out of two elements:

1. Direct compensation. This consists of:

1. Salary. This is the base and variable pay for work.

2. Rewards. Other monetary benefits from working at the company, including

health care, retirement pay, and allowances. 

2. Indirect compensation. This consists of:

1. Work-life balance. A good work-life balance is crucial for a happy career.

2. Recognition. Recognition by colleagues and supervisors, as well as external

recognition for your job.

3. Development & career. Training and development, mentor programs, talent

(mobility) programs.

If you only look at compensation when determining what makes employees happy, you’ll
fall short. Total rewards look at how all aspects of an employee’s work-life impact their
satisfaction. Research shows that Total Rewards offers a valid framework to reduce
employee turnover. 

For years, Gallup tracked employee engagement daily and found that engagement
generally stayed between 30 and 35 percent of employees. This means there is a lot of
work to be done in this area.
k a * J d v
As established above, pay and benefits are not the only things that make employees
happy. Management practices have significant impacts on employee happiness and
profitability and even reduced workplace accidents. Ignoring the culture part of an
employees’ total rewards can reduce company performance and increase turnover.

Warr’s Vitamin model

Another approach to compensation and benefits is Warr’s vitamin model. A vitamin
deficiency produces bodily impairment and may lead to physical illness. Normal vitamin
intake improves health. However, an excess of vitamins can have different effects.
According to Warr, an overdose of vitamins C and E neither improve nor impair the
individual’s health. However, excess of vitamins A and D lead to toxic concentrations,
which causes ill health.

Warr grouped job characteristics in these two categories, CE and AD.

1. CE is short for Constant Effects. Once an optimum is reached, any additional

resources don’t add anything to employee well-being. Examples include 
1. Pay level

2. Pleasant environment

3. Safe work practices

4. Adequate equipment

5. Value to society
k a * J d v
 6. Supportive and considerate supervision

7. Job security

2. AD is short for Additional Decrement. Once the optimum is reached, any

additional resources hurt employee well-being. Examples include 
1. Task discretion

2. Influence

3. Skill use

4. Number of job demands

5. Difficulty of job demands

6. Range of different tasks

7. Future predictability

8. Availability of feedback

9. Amount of social contact.

It is key to identify the optimum level for employees when it comes to compensation and
benefits. Too much will either cost the organization resources (time, money,
administration) in the case of CE, or will decrease employee well-being in the case of AD.

Researchers in Germany found that Warr’s theories did have a correlation with employee
happiness and engagement and business success, at least in the German Horticulture
business. While that may be a very specific area, it’s worth noting that these ideas do have
merit, and looking at the total picture (or making sure employees receive all their vitamins)
has a positive impact on your business.

Simon Sinek’s Why model

Simon Sinek’s Why model can also apply to compensation and benefits. As Warr’s Vitamins
and the Total Rewards Matrix demonstrate, employees want to know the why and
understanding that influences their performance. Sinek says that the best and most
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influential communicators begin with the why – why we do this. And the answer to the
question, “Why?” cannot be to achieve shareholder value. That does not inspire.

Inspiration and understanding of underlying company culture and values increase

engagement, especially among Millennials and Gen Z. The oldest Millennials are now in
their late 30s (defining the millennials as those born between 1981 and 1996), but they
still behave differently than prior generations. They prefer to meet with their managers
one on one–and finding the why in their job is part of this. Millennials want to see
companies benefiting society, not just shareholders. If you can explain why your company
exists, it can impact your millennial turnover and engagement.

Your compensation packages and your total rewards models should not remain static.
There are generational differences. As Gen Z enters the workforce, you’ll note that they
(generally speaking) behave differently than prior generations, and compensation needs
to adjust.

Compensation and benefits package

example
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What should a compensation and benefits package look like? There is no one answer for
that as the package for a grocery store clerk will have little in common with the CEO’s
package. However, here are some standard items that companies often include in a job
offer. You’ll need to adjust for your organization, local laws, and employee level. 

Salary

Overtime pay

Bonuses and commissions (discretionary and non-discretionary)

Retirement (defined benefit and defined contribution plans)

Stock options

Restricted stock

Vacation

Profit-sharing

Merit pay

Sign-on bonuses

Relocation bonuses

Housing, school, and meal reimbursement

Healthcare benefits (medical, dental, vision, etc.)

Salespeople, for instance, will need a commission plan that details what their commission
is, and under what circumstances they receive it (is it when the paperwork for the sale is
signed or is it when the customer pays?). Profit-sharing plans need to define what
constitutes a profit, and when such, the company pays the bonuses (yearly, quarterly?). 

Companies must operate within the confines of laws. Summary Plan Descriptions should
define everything legally, and you should provide these to employees, so they know
precisely what their compensation and benefits are. While all these things are, generally,

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negotiable, you must maintain equity with similarly situated employees, to prevent illegal
or immoral discrimination. 

Compensation packages cannot detail the total rewards aspect of any job offer. But,
understand that your job candidates look for that. Websites such as Glassdoor give
insights into your total rewards, whether you like it or not. It’s important to remember that
candidates consider all that information when deciding to accept or reject a job offer.

You can no longer hide behind a large salary offer and hope that everyone ignores the
culture your office has to offer.

Compensation and benefits are key components for company success, employee
engagement, and turnover. You should evaluate your plans and programs regularly (at
least yearly) to ensure that you meet both employee expectations and remain competitive
in the marketplace.

FAQ
What are compensation and benefits?
Typically, when employees think about compensation, the salary is what they think of.
Benefits cover indirect pay. Think of health insurance, stock options, or various other
things offered to employees.

What is the difference between compensation and benefits?

Put simply, compensation covers people’s direct pay, their salary. Benefits cover
employees’ indirect pay, things like health insurance and stock options but also social
benefits such as parental leave.

Why are compensation and benefits important?

k a * J d v
Compensation and benefits are important for two reasons. First, people won’t work for
you without pay. Second, benefits are a significant expense with a clear goal and thus
not something businesses can overlook.

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Erik van Vulpen

Erik van Vulpen is an expert in shaping modern HR practices by bringing
technological innovations into the HR context. He receives global
recognition as an HR thought leader and regularly speaks on topics like
HR Analytics, Digital HR, and the Future of Work. In his passion to share
his ideas, he founded AIHR, the Academy to Innovate HR in 2016. Which
has since become the #1 leader in online training courses for HR

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discover AIHR's curriculum here.

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