Compensation and benefits

Employee compensation and benefits are divided into four basic categories:

1. Guaranteed pay – a fixed monetary (cash) reward paid by an employer to an employee. The most common form of guaranteed pay is base salary. Guaranteed pay also includes cash allowances (housing allowance, transport allowance, etc.), differentials (shift differentials, holiday differentials) and premiums (night shift, etc.)
2. The Variable pay – a non-fixed monetary (cash) reward paid by an employer to an employee that is contingent on discretion, performance, or results achieved. The most common forms of variable pay are bonuses and incentives.
3. Benefits – programs an employer uses to supplement employees’ compensation, such as paid time off, medical insurance, company car, and more.
4. Equity-based compensation – stock or pseudo stock programs an employer uses to provide actual or perceived ownership in the company which ties an employee's compensation to the long-term success of the company. The most common examples are stock options.

Guaranteed pay is a fixed monetary (cash) reward.

The basic element of guaranteed pay is base salary which is paid on an hourly, daily, weekly, bi-weekly, semi-monthly or monthly rate. Base salary is provided for doing the job the employee is hired to do. The size of the salary is determined mainly by 1) the prevailing market salary level paid by other employers for that job, and 2) the performance of the person in the job. Many countries, provinces, states or cities dictate a minimum wage. Employees' individual skills and level of experience leave room for differentiating income levels within a job-based pay structure.

In addition to base salary, allowances may be paid to an employee for specific purposes other than performing the job. These can include allowances for transportation, housing, meals, cost of living, seniority, or as payments in lieu of medical or pension benefits. The use of allowances varies widely by country, as well as job level and the nature of job duties.

Variable pay is a non-fixed monetary (cash) reward that is contingent on discretion, performance, or results achieved. There are different types of variable pay plans, such as bonus schemes, sales incentives (commission), overtime pay, and more.

An example where this type of plan is prevalent is how the real estate industry compensates real estate agents. A common variable pay plan might be the sales person receives 50% of every dollar they bring in up to a level of revenue at which they then bump up to 85% for every dollar they bring in going forward. Typically, this type of plan is based on an annual period of time requiring a "resetting" each year back to the starting point of 50%. Sometimes this type of plan is administered so the sales person never resets or falls down to a lower level. It also includes Performance Linked Incentive which is variable and may range from 130% to 0% as per performance of the individual as per his key result areas (KRA).

Benefits consist of the non-wage compensation that form the total remuneration package for an employee.

While there is less research in this field,[2] it is an important field, as benefits can create significant costs for employers,[3] be they through compulsory means (e.g. compulsory pension schemes), or by the discretion of the employer (e.g. childcare allowances).[2] Benefits can also be seen as an attractor for potential employees and can reduce turnover.[4]

Employers can offer a wide range of benefits, these generally fall within the categories of:

1. Health and wellbeing - Employee Assistance Programmes (EAP), or a 'wellbeing allowance'.[3]
2. Special leave - Leave to attend to matters outside of work such as sporting commitments, volunteering, or meeting cultural commitments.[3]
3. Career development - Support of study in both payment of fees and paid time to study, and secondment or shadowing opportunities.[3]
4. Retail discounts - Discounts in a retail setting (e.g. Cost plus sales tax offers, for certain retailers).[3]
5. Financial product discounts - Discounts on services such as loan interest rates or insurance policies.[3]
6. Flexible work - Includes working from home (WFH), flexible start and finish times, and reduced hours of work[3] (e.g. the 4 day week[5]).

Reciprocity theory is an important theory underpinning benefits, as it builds a social norm whereby an employer provides a 'positive' benefit, which is warmly received.[4] In return the employee is inclined to provide positive workplace behaviour, strong productivity, and strong organisational commitment which is the bond or attachment that an employee has towards their employer, and subsequent levels of involvement.[4]

Social exchange theory is another relevant theory which suggests that employees weigh up the total benefits and costs of their relationship with the employer.[4][6] If an employee feels the costs of their work or employment relationship outweighs the benefits received from their work, the employee will be more likely to choose to end the employment relationship, to pursue an employment relationship that provides greater regard for benefits and social exchange theory.[4][6]

The motivation for an employer to provide benefits can vary. While the overall intent of benefits is to keep employees satisfied with their employment,[2] employers may provide benefits to mitigate disruption caused by increased union density and increased bargaining power.[2] In other instances, employers may provide benefits as a result of a union bargaining for strengthened benefits.[2]

When an employer provides benefits, it is critical to note that benefit systems must adhere to the principles of organisational justice.[7] Organisational justice is seen as ‘the extent to which employees perceive workplace procedures, interactions and outcomes to be fair in nature’.[7] The principles of organisational justice include:

1. Procedural justice - How fair policies and procedures are perceived.[3]
2. Informational justice - How fair rationale for benefit policies, procedures, and outcomes are perceived.[3]
3. Interpersonal justice - How fair interactions are regarding benefits perceived.[3]
4. Distributive justice - How fair access to benefits are perceived.[3]

If an employee perceives that the benefits system lacks organisational justice, the perceived or actual satisfaction with benefits is undermined.[3]

The overall satisfaction with the system of benefit administration is called the benefit system satisfaction,[4] while benefit level satisfaction refers to the satisfaction an employee has 'with the amount of benefits they receive'.[4]

It is important to note that benefit satisfaction can be viewed as actuarial value benefit satisfaction and perceived level of benefits.[2] it is interesting to note that some employees are more satisfied with the perceived value of benefits.[2] This could include an employee having the potential benefit of flexible working, which may not be utilised. The employee will still note satisfaction with the potential benefit.[2]

However, benefit system satisfaction, is based on the:

1. Satisfaction of the administration.[4]
2. Determination of the benefit.[4]

Benefit systems which are seen to be of value and managed well, will result in satisfied employees.[8] These employees will feel that their employer is supportive of them, and their ‘perceived organisational support’ will increase.[4] This is important as perceived social or organisational support can be one of the most significant factors in building resilient employees and reducing unplanned turnover.[4][9]

Employees will also build a sense of emotional commitment towards their employment which will foster in them a willingness to perform highly.[4]

While an employer may establish benefits, it is worth considering the importance of demographics on benefit satisfaction.[2] For example, a workforce with a significant number of parents may value a benefit package which is centred around supporting them and their children. However, those without children, may perceive these benefits as unfair, irrelevant, and a financial disadvantage as they cannot gain the same financial benefits as employees with children.

Pay dispersion is defined as the ‘differences in pay levels between individuals within (i.e., horizontal dispersion) and across (i.e., vertical dispersion) jobs or organisational levels.[10] Vertical pay dispersion is specifically the difference in remuneration between the most senior employees of an organisation (e.g., Executive Directors of Chief Executive) and an average employee.[11]

Vertical pay dispersion has recently become a topic of political, social and news media discussions. In particular, special attention is paid toward cases where the difference of an executive director of an organisation is seen to be disproportionately high, when compared to the rest of the workforce and the difference in pay is visible within the organisation.[11] Whether an organisation is in the public sector or private sector, research shows people care about the difference between what they are paid and what those at the highest level are being paid – it is important to an employee.[11]

There can be short-term and long-term effects of vertical pay dispersion. Research suggests some short-term effects of vertical pay dispersion can lead to increased outputs and productivity in employees. This is based on the idea that competition is a driver of human motivation, and prizes such as a change in status or remuneration in an organisation (e.g., promotion to a higher-paid position) or other extrinsic motivators can encourage employees to perform better within their role.[12] Research on the long-term effects of higher vertical pay dispersion in an organisation are commonly negative, and usually are associated with dysfunctional behaviour in employees,[13] increased employee turnover,[14] short-sightedness,[15] reduced teamwork and lower intrinsic motivation.[16]

There are academic theories which help to explain why vertical pay dispersion exists within an organisation, and how it can have both positive and negative effects.

Equity-based compensation is an employer compensation plan using the employer's shares as employee compensation. The most common form is stock options, yet employers use additional vehicles such as restricted stock, restricted stock units (RSU), employee stock purchase plan (ESPP), performance shares (PSU) and stock appreciation rights (SAR). A stock option is defined as "a contract right granted to an individual to purchase a certain number of shares of stock at a certain price (and subject to certain conditions) over a defined period of time."[18] Performance shares (PSU) awards of company stock given to managers and executives only if specified organization performance criteria are met, such as earnings per share target[19]

An employee may receive intangible benefits, such as a desirable work schedule. That could be a schedule that is controlled by the employee and can be adjusted to accommodate occasional non-work activities, or one that is highly predictable, which makes it easier for the employee to arrange childcare or transportation to work.

In New Zealand, many government[20] organisations offer flexible work arrangements as part of their benefits. This may include flexible workplace arrangements or flexible time. Flexible workplace may include working from a remote workplace (usually a home office) for anything from 2 – 5 days per week. Flexi-time arrangements are beneficial for employees who have school going children or other commitments. These could include reduced hours, hours completed outside of normal work hours i.e. 40 hours per week but just not between the traditional 8am to 5pm. Other flexi-time arrangements include what is known as an 80 hour fortnight – usually a 9 hour day for 9 days and then the 10th day taken as time in lieu.

Access to training programs, mentorship, opportunities to travel or to meet other people in the same field, and similar experiences are all intangible benefits that may appeal to some employees.

Self determination theory (SDT) [21] suggests that  people in the workplace are generally motivated by either intrinsic or extrinsic rewards or rather lie on a continuum between the two.

Extrinsic rewards are tangible or visible rewards and can include financial compensation (salary, wages, bonuses etc.) and promotion.

In their book “The 5 Languages of Appreciation in the Workplace”,[22] Gary Chapman and Paul White suggest that employees have preferred or dominant “language” when appreciation is expressed extrinsically. They identify the following extrinsic rewards:

1.      Words of affirmation – this can be praise for an accomplishment, affirming character or praise for a personality trait. These can be given very publicly, within a team or privately depending on the recipient.

2.      Quality time – This is giving of your most precious commodity - time – to express appreciation.

3.      Acts of service – doing something for an employee, or colleague to express your appreciation for them.

4.      Tangible gifts – this can be as simple as buying an employee or colleague a cup of coffee or giving them some time off as a gift for work well done.

5.      Physical touch – this can be a high five or handshake (be careful!!!)

In all of these they caution on the need to maintain the appropriateness of the interaction.

Intrinsic rewards refer to internal factors that motivate a person to undertake work or a task. These can include a sense of accomplishment, learning and personal growth, creativity or work that gives one purpose and meaning.

Research[23] shows that public employees placed higher value on intrinsic rewards, particularly if they elevated or high levels of Public Service Motivation (PSM). PSM can be defined as “an individual's predisposition to respond to motives grounded primarily or uniquely in public institutions and organizations”.  This concept has been correlated with numerous variables such preferences for reward, job satisfaction, commitment and performance. Literature suggests that an increased level of PSM is associated with an individual's desire to serve in the public interest. Public employees placed a significantly higher value on work that is helpful to society over their private sector counterparts. They also valued interesting work and job security. A significant positive correlation exists between PSM, job satisfaction, performance and commitment. Despite this, research[23] has found that extrinsic rewards can be important in both public and private organisations.

Extrinsic rewards can be effective in motivating people, especially in situations where the task or behaviour may not be inherently enjoyable or when a specific outcome needs to be achieved. However, relying too much on external ort extrinsic rewards can actually lead to a decrease in internal or intrinsic motivation,[24] or the desire to do something because it is enjoyable or rewarding in itself. If people come to expect external rewards for everything they do, they may lose their natural interest and internal drive for the task itself. However, it's important to note that overreliance on extrinsic rewards can sometimes lead to a decrease in intrinsic motivation[5]. If people come to expect external rewards for everything they do, they may lose their natural interest and internal motivation for the task itself.

Balancing extrinsic and intrinsic motivation is often essential for promoting sustained interest and engagement in activities and behaviours. Effective motivation strategies take into account the individual's unique needs and preferences, while also recognizing the role that both types of rewards play in influencing behaviour. It is important to achieve the right blend of intrinsic and extrinsic rewards within the overall compensation and benefits offered to an employee.

Various combinations of the above four categories are referred to as pay aggregates. Common aggregates are explained below.

Together, guaranteed and variable pay comprise total cash compensation. The ratio of base salary to variable pay is referred to as the pay mix. For example, a person receiving a bonus equal to 25% of base salary would have an 80/20 pay mix. Organizations often set the total cash compensation for sales people at a market level, then they split the total cash compensation into the base salary component and the incentive component following a 70/30 pay mix, while other (non-sales) employees may have a 90/10 pay mix.

Total guaranteed package or fixed cost to company are aggregates that include guaranteed pay and benefits. This represents the total fixed cost of the reward package and is useful for budgeting. All forms of variable pay (annual bonus and equity compensation) are excluded from this aggregate.

Total direct pay refers to total cash compensation plus equity compensation. Benefits are excluded from this aggregate. Total direct pay includes all the elements that may be negotiated by a job candidate, especially for senior executive positions where annual and long-term incentives are more substantial.

Total compensation would include all four categories: guaranteed pay (salary and allowances), variable pay, benefits and equity compensation.

Remuneration is a term often used to refer to total cash compensation or total compensation.

As noted above, total rewards would include total compensation as well as intangible benefits such as culture, leadership, recognition, workplace flexibility, development and career opportunity.

In most companies, compensation & benefits (C&B) design and administration falls under the umbrella of human-resources.

HR organizations in large companies are typically divided into three sub-divisions: HR business partners (HRBPs), HR centers of excellence, and HR shared services. C&B is an HR center of excellence, like staffing and organizational development (OD).

Employee compensation and benefits main influencers can be divided into two: internal (company) and external influencers.

The most important internal influencers are the business objectives, labor unions, internal equity (the idea of compensating employees in similar jobs and similar performance in a similar way), organizational culture and organizational structure.

The most important external influencers are the state of the economy, inflation, unemployment rate, the relevant labor market, labor law, tax law, and the relevant industry habits and trends.

Bonus plans are variable pay plans. They have three classic objectives:
1. Adjust labor cost to financial results – the basic idea is to create a bonus plan where the company is paying more bonuses in ‘good times’ and less (or no) bonuses in ‘bad times’. By having bonus plan budget adjusted according to financial results, the company's labor cost is automatically reduced when the company isn't doing so well, while good company performance drives higher bonuses to employees.
2. Drive employee performance – the basic idea is that if an employee knows that his/her bonus depend on the occurrence of a specific event (or paid according to performance, or if a certain goal is achieved), then the employee will do whatever he/she can to secure this event (or improve their performance, or achieve the desired goal). In other words, the bonus is creating an incentive to improve business performance (as defined through the bonus plan).
3. Employee retention – retention is not a primary objective of bonus plans, yet bonuses are thought to bring value with employee retention as well, for three reasons: a) a well designed bonus plan is paying more money to better performers; a competitor offering a competing job-offer to these top performers is likely to face a higher hurdle, given that these employees are already paid higher due to the bonus plan. b) if the bonus is paid annually, employee is less inclined to leave the company before bonus payout; often the reason for leaving (e.g. dispute with the manager, competing job offer) 'goes away' by the time the bonus is paid. the bonus plan 'buy' more time for the company to retain the employee. c) employees paid more are more satisfied with their job (all other things being equal) thus less inclined to leave their employer.

The concept saying bonus plans can improve employee performance is based on the work of Frederic Skinner, perhaps the most influential psychologist of the 20th century. Using the concept of Operant Conditioning, Skinner claimed that an organism (animal, human being) is shaping his/her voluntary behavior based on its extrinsic environmental consequences – i.e. reinforcement or punishment.

This concept captured the hearts of many, and indeed most bonus plans nowadays are designed based on it, yet since the late 1940s a growing body of empirical evidence has suggested that these if-then rewards do not work in a variety of settings common to the modern workplace. The failings of the bonus plan often relate to rewarding the wrong behaviour. For example, managers who keep to the status quo, fire valuable (expensive) employees, and engage in immoral business practices can achieve better short-term financial outcomes (and therefore a bonus) than a manager who is attempting to innovate his or her way to higher profits. When bonus plans are poorly thought out, they have the potential to damage employee performance and cause regulatory headaches.[25] However, despite their failings, employees (and many employers) still view an effective bonus plan as the single greatest motivator in the workplace.[26][27]

• Reward management