CHAPTER 6

COMPENSATION

NATURE OF COMPENSATION
The word compensation has various connotations for different types of employees.
For some, compensation means the whole package of basic salary and benefits that the
company provides.
Compensation is defined as the means of giving monetary value equivalent to any
work performed by an employee. It is also referred to as all financial rewards and non-
financial rewards which an employee may receive out of work rendered for the employer
(Milkovich, Newman, & Gerhart, 2013).

BASIC TYPES OF COMPENSATION

Base Pay
It is the basic pay given to the employee for the actual work rendered usually in
the form of salary or wage. It is the pay that was negotiated and agreed upon by the
employee and the employer during the hiring process.
Base pay is expressed in the form of salary or wage which many people use
interchangeably. The term salary refers to a fixed amount of pay which is given usually
twice a month, while the term wage is used to mean hourly or daily based pay for any
work rendered for a particular day (Surbhi, 2015).
It is determined by the level of skills required, educational background, work
experience, job grade, and position of an employee. It is also negotiated during collective
bargaining agreements, developed by using market rate analysis and job evaluation.

Variable Pay
It is the pay linked to actual accomplishments in performance such as bonuses or
incentives based on a target sales quota or target productivity.
Incentives can be paid on an individual, group, or team basis. In a much wider
scope, incentives can be provided for all employees regardless of rank (Armstrong. 2015).
There are various reasons for giving incentives. One reason may be large
reduction in expenses or an increase in sales volume. For some companies, revenue
growth that exceeds projection is tantamount to an organization-wide incentive. Another
reason may also be because of high customer satisfaction and an increased percentage
of loyal customers (Milkovich, Newman, Gerhart, 2013).
Benefits
These are the indirect rewards that may either be government-mandated or
voluntarily given by the employer. Examples are health insurance and vacation and sick
leaves.
Benefits help employees to further cope with the demands of the job and their
personal life. Some companies make their benefits attractive to entice job seekers who
would like to work for companies that will take care of them for a long time. Some would
extend the benefits to the employees’ dependents, such as hospitalization and insurance
benefits.
Large companies that are profitable and with large capitalization provide more than
what is mandated by law since they can afford to do so. Whereas small-sized companies
can only provide what the government dictates.

OBJECTIVES OF COMPENSATION
1. To retain high performance employees and reduce employee turnover;
2. To achieve high productivity and efficiency by providing fair compensation among
employees commensurate to their position; and
3. To satisfy pay requirements in accordance with the law.

CLASSIFICATION OF COMPENSATION
1. Direct Compensation – refers to an actual monetary value that entitles an
employee. It can be in the form of a salary or wage. It can also be in the form of
variable pay, such as bonuses, incentives, commissions, and other performance-
based pay. Money is usually attached to direct compensation.

2. Indirect Compensation – refers to non-monetary aspects of compensation, such

as benefits packages that include hospitalization and life insurance plans, sick and
vacation leaves, car plans, and educational grants among others. It is usually
referred to as the “add-on” or the extra component of base pay (Armstrong, 2015).
COMPONENTS OF A COMPENSATION SYSTEM
The establishment of a fair compensation system needs key components to make
them more credible to employees. These components help in putting value on different
positions which eventually becomes the basis for determining the specific compensation
package. The components are the following:
1. Job Analysis – it is defined as the process of determining all the information
specific to a particular job. The different tasks or activities, such as drafting,
drawing, writing, teaching, and encoding are obtained. There is also additional
information that is necessary to determine the right compensation for a particular
position such as: how tasks are performed, the time they are performed, and the
reasons why they are done.

2. Job Description – It is referred to as the written summary of all the duties and
responsibilities of a particular job position. It also includes the job specification
which describes the educational background, experience, skills, and personal
traits that are needed to perform a particular job.

3. Job Evaluation – while job analysis provides all the information for each job, job
evaluation is the process of determining the worth of a job (Dessler, 2015). The
worth or value of the job in the organization forms a big part in determining pay
rates, specifically basic pay. It also organizes jobs into a hierarchy as pay levels
are developed.

4. Pay structures – many organizations standardized their pay and use grades or
levels. Pay structures help in determining entry pay and incremental increases
during the performance evaluation or promotion. They minimize complaints on the
corresponding number of increases because they are structured and
systematically arranged per grade or level.

5. Salary surveys – some organizations participate in salary surveys and purchase

market data on prevailing rates for different positions in the industry where they
belong. These help in determining appropriate rates and at the same time
remaining competitive among competitors.

6. Policies and Regulations – each organization has its policies for administering
and implementing its payment system. These depend on many factors including
the organization’s capacity to provide compensation and the standards set by law.
They also indicate the kind of support that the top management has given in the
implementation of compensation packages.
DIFFERENCE BETWEEN WAGE AND SALARY