Learn about all the types of compensation available for employees.
The level of compensation is usually established by determining what employees at other firms with similar job characteristics earn. Information on compensation levels can be obtained by conducting a salary survey or from various publications that report salary levels for different jobs.
The wide differences in compensation among job positions are attributed to differences in the supply of people who have a particular skill and the demand for people with that skill.
The types of employee compensation are:-
1. Salary 2. Stock Option 3. Commissions 4. Bonuses 5. Profit Sharing 6. Employee Benefits 7. Perquisites
8. Base Compensation 9. Supplementary Compensation 10. Variable Compensation 11. Intrinsic vs. Extrinsic Rewards 12. Financial vs. Nonfinancial Rewards 13. Performance-based vs. Membership-based Rewards.
List of all Types of Employee Compensation: Salary, Stock Options, Commissions, Bonuses, Profit Sharing Perquisites and Few Others
Types of Employee Compensation- Typical Elements: Salary, Stock Options, Commissions, Bonuses, Profit Sharing, Employee Benefits and Perquisites
Firms attempt to reward their employees by providing adequate compensation. The level of compensation is usually established by determining what employees at other firms with similar job characteristics earn. Information on compensation levels can be obtained by conducting a salary survey or from various publications that report salary levels for different jobs.
The wide differences in compensation among job positions are attributed to differences in the supply of people who have a particular skill and the demand for people with that skill.
For example, demand for employees who have extensive experience in business financing decisions is high, but the supply of people with such experience is limited. Therefore, firms offer a high level of compensation to attract these people. Conversely, the supply of people who can qualify as a clerk is large, so firms can offer relatively low compensation to hire clerks.
A compensation package consists of the total monetary compensation and benefits offered to employees. Some employees think of their compensation only in terms of their salary, but the benefits that some firms offer may be more valuable than the salary. The typical elements of a compensation package are salary, stock options, commissions, bonuses, profit sharing, benefits, and perquisites.
Salary (or wages) is the dollars paid for a job over a specific period. The salary can be expressed per hour, per pay period, or per year and is fixed over a particular time period.
Stock options allow employees to purchase the firm’s stock at a specific price. Consider employees who have been given stock options to buy 100 shares of stock at a price of $20 per share.
This means that they can purchase the stock for this price, regardless of the stock’s market price. Thus, even if the stock s market price rises to $30 per share, the employees can still buy the stock for $20 per share.
They would need $2,000 (computed as 100 shares X $20 per share) to purchase 100 shares. If the firm performs well over time, the stock price will rise, and their 100 shares will be worth even more. Thus, these employees are motivated to perform well because they benefit directly when the firm performs well. As part-owners of the firm, they share in its profits.
Many firms provide stock options to their high-level managers, such as the CEO, vice-presidents, and other managers. Some firms, however, such as Starbucks and Microsoft, provide stock options to all of their employees. This can motivate all employees to perform well.
Starbucks grants stock options to its employees in proportion to their salaries. An employee who received a salary of $20,000 in 1991 would have earned more than $50,000 by the year 2000 from owning the stock options.
Microsoft attributes much of its success to its use of stock options. Because of its strong performance (and therefore substantial increase in its stock price) since 1992, its managers who were hired in 1992 or before are now millionaires because their shares are worth more than $1 million.
A recent annual report of Wal-Mart summarized the potential benefits to a firm that uses stock options to compensate employees:
“The ownership of Wal-Mart stock and options by directors and senior management is important because these individuals represent the Shareholders and should act in a manner consistent with the long-term interests of Shareholders. Making equity part of their compensation helps achieve this objective.”
In order to hire and retain talented employees, Amazon(dot)com uses stock options as a major part of its compensation. By providing stock options, its employees have ownership in the firm, and their business decisions can affect the value of the shares they own. As the following comment indicates, Amazon believes that its success is highly influenced by its ability to motivate its employees-
“We will continue to focus on hiring and retaining versatile and talented employees, and continue to weight their compensation to stock options rather than cash. We know our success will be largely affected by our ability to attract and retain a motivated employee base, each of whom must think like, and therefore must actually be, an owner.” — Amazon(dot)com
How Options Can Cause a Conflict of Interests:
Stock options can also lead to problems for a firm’s shareholders, however. When the top managers use their stock options to obtain the firm’s stock, they want to sell that stock during a period when the stock’s price is high.
Although owning stock is supposed to encourage managers to improve the firm so that they benefit from a higher stock price, stock ownership may tempt them to manipulate the financial statements to boost the stock price. In some cases, a firm’s managers have increased investor demand for the stock by using accounting methods that temporarily boosted the firm’s earnings.
The high demand caused the stock price to rise, allowing the managers to sell their holdings of stock at a high price. When investors learned that the firm’s earnings were exaggerated, they sold their stock, causing the price to decline, but by that time the managers had already sold their shares.
During the 2001-2002 period, managers of several firms, including Enron, Global Crossing, and WorldCom, were accused of using accounting to inflate their earnings and mislead investors in this way.
Some firms not only exaggerated their earnings, but failed to disclose financial problems. In several cases, managers knew of problems at a firm but withheld relevant information from the public until after they had sold their holdings of the firm’s stock.
The managers issued overly optimistic financial reports so that other shareholders would not sell the firm’s stock and cause the price to decline until the managers had sold their shares. Thus, the managers were able to benefit at the expense of other investors who purchased the stock from them at a high price without realizing the firm’s financial problems.
As an example, Enron manipulated its earnings so that they increased over 20 consecutive quarters leading up to 2001. Enron’s stock price rose over time along with the earnings. When investors recognized that Enron was manipulating its earnings, however, they dumped the stock, and the stock price declined abruptly in 2001. In November 2001, Enron filed for bankruptcy.
Yet, before Enron’s price declined, 29 Enron executives or board members sold their holdings of Enron stock for more than $1 billion. In particular, Enron’s CEO sold more than $100 million worth of Enron stock before the financial problems were disclosed.
The CEO and other top managers were able to sell their shares at a high price because other shareholders did not know about Enron’s problems. Thus, the managers benefited at the expense of the other shareholders. Similar abuses have occurred at other firms, although to a lesser extent.
The lesson of the Enron scandal is that managers who receive stock options as compensation may be tempted to manipulate the firm’s stock price so that they can sell their shares at a high price. Although managers cannot control the stock’s price directly, they can influence the price indirectly through the information that they release or withhold.
Thus, they have an incentive to exaggerate the earnings, issue overly optimistic reports, or withhold bad news; by doing so, they can indirectly push the stock price higher and then sell their stock holdings at a high price.
A firm’s board of directors should attempt to prevent such abuses. The board of directors can enact guidelines that allow the managers or board members to sell only a small amount of their stock holdings in any particular quarter or year.
In this way, the managers will not have an incentive to create an artificially high stock price in any particular quarter or year because they will not be able to sell all of their stock at that time.
Commissions normally represent compensation for meeting specific sales objectives. For example, salespeople at many firms receive a base salary, plus a percentage of their total sales volume as monetary compensation. Commissions are not used for jobs where employee performance cannot be as easily measured.
A bonus is an extra onetime payment at the end of a period in which performance was measured. Bonuses are usually paid less frequently than commissions (such as once a year). A bonus may be paid for efforts to increase revenue, reduce expenses, or improve customer satisfaction.
In most cases, the bonus is not set by a formula; thus, supervisors have some flexibility in determining the bonus for each employee. The total amount of bonus funds that are available for employees may be dependent on the firm’s profits for the year of concern.
At Disney 70 percent of the bonus compensation for executives is based on specific financial performance measures, such as earnings. The advantage of using these types of measures is that executives are encouraged to focus on specific financial goals that should also satisfy the company’s shareholders.
Some firms, such as Continental Airlines and General Motors, offer employees profit sharing, in which a portion of the firm’s profits is paid to employees. Boeing, J.P. Morgan Chase, and many other firms also offer profit sharing to some of their employees. This motivates employees to perform in a manner that improves profitability.
Employees may also receive employee benefits, which are additional privileges beyond compensation payments, such as paid vacation time; health, life, or dental insurance; and pension programs. Typically, these employee benefits are not taxed. Many firms provide substantial employee benefits to their employees. The cost of providing health insurance has soared in recent years.
Many firms, such as Johnson & Johnson, have responded by offering preventive health-care programs. Some firms now give employees incentives to stay healthy by reducing the insurance premiums charged to employees who receive favorable scores on cholesterol levels, blood pressure, fitness, and body fat.
Some firms offer perquisites (or “perks”) to high-level employees; these are additional privileges beyond compensation payments and employee benefits. Common perquisites include free parking, a company car, club memberships, telephone credit cards, and an expense account.
The forms of compensation allocated to employees vary with their jobs. Employees who are directly involved in the production process (such as assembly-line workers) tend to receive most of their compensation in the form of salary. Low-level managers may also receive most of their compensation as salary but may receive a small bonus and profit sharing.
Many salespeople in the computer and technology sectors earn more compensation in the form of commissions than as salary. High-level managers, such as vice-presidents and CEOs, normally have a high salary and the potential for a large bonus. Their employee benefits are also relatively large, and they normally are awarded various perks as well.
Types of Employee Compensation – Base Compensation and Supplementary Compensation
Compensation paid to employees may be classified as:
Base compensation involves monetary benefits in the form of wages and salaries. The term ‘wage’ is used to denote remuneration to workers who are paid on basis of hours worked or on the basis of their productivity and the term ‘salary’ is usually defined to mean compensation to office employees, foremen, managers and professional and technical staff.
Supplementary compensation includes’ fringe benefits’ offered through several employee services and benefits such as housing, subsidized food, medical aid, creche, etc. It helps to retain the employees on a long term basis.
1. Monthly wage and salary or total pay including wage, house rent allowance, dearness allowance and city compensatory allowance.
2. Bonus at the end of the year
3. Economic benefits such as – paid holidays leave travel concessions.
4. Contribution towards insurance premium
5. Contribution towards retirement benefits such as – employee provident fund
6. Transport and medical facilities.
7. Allowances –
Some of these allowances are –
i. Dearness Allowance – Dearness Allowance calculated as a percentage of salary is given to protect real income of an employee against price rise.
ii. House Rent Allowance – House Rent Allowance calculated as a percentage of salary is given by those companies that not provide living accommodation to their employees but pay house rent allowance (HRA).
iii. City Compensatory Allowance – This allowance is paid basically to employees in metro cities and other big cities where cost of living is comparatively more.
iv. Transport Allowance/Conveyance Allowance – Some companies pay transport allowance (TA) that accommodates travel from the employee’s house to the office. A fixed amount is paid every-month to cover a part of travelling expenses.
8. Incentives and Performance Based Pay –
Incentive compensation is performance-related. Remuneration is paid with a view to encourage employees to work hard and do better. Both individual incentives and group incentives are applicable in most cases. Bonus, gain-sharing, commissions on sales are some examples of incentive compensation.
9. Fringe Benefits/Perquisites –
Fringe benefits include employee benefits like medical care, hospitalization, accident relief, health and group insurance, canteen, uniform, recreation and the likes.
Types of Employee Compensation- 3 Major Types: Base Compensation, Variable Compensation and Supplementary Compensation
There are three types of Compensation:
These are being discussed one by one below:
1. Base Compensation and Benefits:
Base Compensation is one type of Compensation. It refers to the basic salaries and wages given to the employees. It is normally constant at a given amount irrespective of the difference in work performance.
i. Demand and supply of labor in the market.
ii. Labor union pressure is also another factor influencing Base Compensation.
iii. Nature of job as determined by the job description, each employee deserves a different compensation package.
iv. Size of the organization and its ability to pay its employees.
v. Product market compensation is yet another factor influencing Base Compensation.
vi. Psychological and social factors like employee satisfaction and security.
vii. Salaries paid by similar firms are also a factor affecting Base Compensation.
viii. Government policies on wage determination.
ix. Cost of living of the employees. When the employees’ cost of living is very high then they need a higher compensation benefit.
x. Increase in productivity of labor.
xi. Companies in general; whether competing companies or not.
2. Variable Compensation and Benefits:
Variable pay, also known as incentive pay, refers to pay earned beyond an employee’s normal weekly, monthly or annual salary. Not a guarantee, it is paid out only if an individual or team achieves a goal. Variable pay is also known as employee compensation that changes as compared to salary which is paid in equal proportions throughout the year.
Variable pay is used generally to recognize and reward employee contribution toward company productivity, profitability, teamwork, safety, quality, or some other metric deemed important.
The employee who is awarded variable compensation has gone above and beyond his or her job description to contribute to organization success. Variable pay is awarded in a variety of formats including profit sharing, bonuses, holiday bonus, deferred compensation, cash, and goods and services etc.
Many high achievers, eager to be part of a dynamic work environment, view variable pay as an important factor when choosing an employer. However, variable pay cannot fix poor management or employees’ problems related to mistrust or low morale.
As such, the greater the flexibility and variety of the benefits program, the more likely all of your employees are to feel appreciated. This type of compensation as by its name is variable. It means that one gets compensation as per the work done. If one does a remarkable job then he or she deserves a higher compensation package than one whose work is of poor quality.
i. The performance of the employee vis-a vis the bottom line
ii. Corporate culture
iii. Source of funding variable pay
iv. Measuring an activity so it can be included in a variable-pay plan.
3. Supplementary Compensation and Benefits:
Supplementary Compensation is compensation given by an employer when he or she wishes to. It is not compulsory or a routine once one is given the compensation that one will be awarded another time. In this type of Compensation the employer has a right to add, deduct or even withdraw the benefits when he or she wishes to.
Compensation comes in three different types that are base compensation, variable compensation and supplementary compensation and Benefits.
Now a days, the organizations use supplementary compensation over and above the base compensation. It helps in satisfying the employees as well as retaining them for long time. It can be given in form of various services like housing, medical, educational facility. Supplementary compensation is also called fringe benefit as well as hidden payroll. The basic purpose of fringe benefit is to maintain efficient human resources in the organization and to motivate the employees.
i. Protection against hazards – supplementary compensation helps in protecting against the hazards of illness, injury, old age, death, permanent disability.
ii. Employee services – some big organizations provide housing, low-cost loan, food, medical, and day care centre for children, educational facilities to their employees for their services.
iii. Payment for time not worked – the employees are also paid for the time they are not working like wash up time, lunch period, vacations, holidays, sick leave etc.
iv. Legal payments – payment under this category involves unemployment; layoff compensation, old age benefits etc.
Thus, there are various kinds of supplementary compensation which are given to the employees.
Types of Compensation – Put Forward by Decenzo and Robbins: Intrinsic vs. Extrinsic Rewards, Financial vs. Nonfinancial Rewards and a Few Others
Compensation or organizational reward includes anything an employee values and desires and an employer is able and willing to offer in exchange for employee contribution.
According to Decenzo and Robbins (2008) the most typical types of rewards are intrinsic vs. extrinsic, financial vs. nonfinancial and performance-based vs. membership based rewards.
These offer personal satisfaction. These are self-initiated rewards such as pride in one’s work, a sense of accomplishment or enjoyment of being in a team. Job enrichment offers intrinsic rewards by making the job more meaningful.
These are the benefits provided by the employer such as money, promotion etc.
These come mainly from management which is an external source.
These are the rewards which directly enhances the well-being of an employee (such as salary, bonuses, profit sharing etc.), or indirectly through retirement plans, paid holidays, sick leave or purchase discounts.
There are rewards which do not directly the increase the employee’s financial position but add attraction to job (e.g., Office furniture, parking space, own secretary and impressive titles etc).
Performance-based rewards are commissions piece work pay plans, incentive systems, group bonuses, merit pay etc., which are based on performance.
Membership based rewards are based on the section where one works, seniority, credentials [educational achievement] specialized skill, labour- market conditions etc.
Though money is obviously a powerful tool to capture the workers’ interest and maximize their productivity, the impact of nonfinancial awards is equally strong.