Chapter Seven: Compensation Page 1
CHAPTER SEVEN
COMPENSATION
1. DEFINITION
It refers to all forms of pay or rewards going to employees and arising from their employment.
Employee compensation has two components. It includes direct financial payments in the form of
wages, salaries, incentives, commissions, and bonuses; and indirect payments (fringe benefits) in the
form of financial benefits like employer-paid insurance and vacations.
Employees need to be rewarded for the service they provide an organization. The organization, on
the other hand, has the obligation to reward employees fairly according to the contribution they
provide to the organization. Organizational reward includes, both intrinsic and extrinsic, that are
received as a result of employment by the organization.
Intrinsic rewards: rewards that are internal to the individual and are normally derived from
involvement in certain activities or tasks. Example: job satisfaction, feelings of accomplishment, etc.
Extrinsic rewards: these are directly controlled and distributed by the organization and are more
tangible. Example: salaries and fringe benefits. Provision of extrinsic rewards usually leads to
intrinsic reward.
Compensation should be equitable to the employer and the employee alike. It should be adequate in
order to meet the needs of the employees, the employers and also meet the minimum requirements of
the government, union and management. Just like other human resource functions, compensation
policies and procedures are also affected by internal and external factors in the environment
including government regulations, economic conditions, union’s influence and demand, the labor
market, wage rates offered by competitors, organization’s financial condition, its size and complexity,
managerial philosophy and strategy, etc.
2. IMPORTANCE OF COMPENSATION
To employees:
▪ It is the primary (and often the only) source of income for employees and their family.
▪ It is a fair reward for the work employees perform and the benefit they provide for the employer.
▪ It determines employees’ social status. Income level is often used as a measure of a person’s worth.
To employers:
• To attract capable employees to the organization
• To motivate them towards superior performance level
• To retain their services for an extended period of time
3. FACTORS AFFECTING COMPENSATION
a. Government: government rules, regulations, executive orders, and laws have their influence on an
organization’s compensation policy. Every government provides laws for compensation in areas like,
minimum wage rate, equal pay provisions – to avoid pay differentials based on sex in jobs requiring
substantially equal skill, effort, responsibility, and working conditions. etc
b. Cost of Living: Cost of living as measured in terms of consumer price index may affect the
organization’s compensation policy as it tries to adjust its employees’ earning to the rate of inflation.
This process is called cost of living adjustment (COLA). As per the policy of the organization,
compensation could be adjusted at the same rate as the inflation or at different rates.
c. Comparable wage rates: The wage pattern in the industry and community could have an impact on
the compensation policies and practices of organizations. Comparing wage and salary rates in given
areas may help in ensuring that the organization is offering a salary that is not substantially higher or
lower than those paid by others in the same area. Comparison could also be done based on
occupation to provide a comparable pay to similar occupations around the country.
In order to ensure that a comparable level of payment is offered to employees, organizations conduct
