Definition of Compensation
What is compensation?
Compensation (also comp or pay practices) is payment made to an employee for services rendered. These payments can be monetary or non-monetary.
Examples of compensation:
- 401(k) plan
- Base hourly wages
- Base salary
- Car allowance
- Disability insurance
- Education assistance
- Flexible spending accounts
- Free snacks and lunches
- Gift and discounts
- Housing allowance
- Incentive plan
- Life insurance
- Medical, dental, and vision insurance
- Overtime pay
- Paid time off
- Premium pay
- Profit sharing distributions
- Recognition awards
- Stock options
- Wellness benefits
Theoretically, compensation is a discipline of human resources that involves:
- Analyzing pay practices to determine what best appeals to job seekers and employees
- Benchmarking compensation to gauge what other industry employers are offering
- Building a compensation infrastructure — pay and reward philosophy, overall pay practice and reward equity process, job analysis, job evaluation, market pricing, pay ranges, etc.
- Ensuring compliance with compensation laws
- Handling specialized forms of pay practices — e.g., executive, global, and sales
- Knowing the different types of comp options — e.g., base pay, variable pay, direct compensation, indirect compensation, etc.
- Making adjustments to compensation, such as pay increases
Compensation laws are primarily enacted at the federal and state levels, though some localities also have their own laws.
Compensation laws cover the following (and more):
- Child labor
- Deductions from wages
- Equal pay
- Hours worked
- Minimum wage
- Taxability of compensation
- Wage garnishment
Note: The Fair Labor Standards Act (FLSA) is the federal law that governs many comp practices — including minimum wage and overtime — for private-sector employers.
Why compensation is important for HR leaders
The role of managing compensation largely falls on the HR department, and success hinges on how well it is done.
When done right, compensation management can help you:
- Attract qualified candidates
- Boost productivity
- Improve employee satisfaction
- Increase profitability
- Maintain compliance
- Raise employee motivation
- Reduce turnover
- Strengthen employee loyalty
When done wrong, compensation management can lead to a string of headaches.
For example, without solid compensation packages, you’ll likely struggle to attract qualified candidates. Additionally, your employees may think you’re short-changing them — which can adversely impact motivation, engagement, productivity, turnover, and profitability.
What’s more, a shaky comp system is vulnerable to noncompliance, which can result in expensive and stringent governmental penalties.
To avoid these consequences, HR leaders must have a detailed understanding of comp programs and a solid compensation strategy. This includes functions such as analysis, benchmarking, and infrastructure. Additionally, HR must collaborate with other departments on pay practice matters, including the payroll, benefits, and finance teams to ensure there is a clear picture of employee total compensation packages.
The history of compensation
Compensation dates back to the 1st century BC when workers were paid in the form of basic living necessities, such as food and shelter. A clay tablet from 3100 BC reveals that some workers in Mesopotamia received beer rations as payment for work performed.
During the Roman times and throughout the Middle Ages, salt became a highly valuable product. As a result, Roman soldiers received their wages in salt instead of currency. Their monthly allowance was referred to as “salarium.” Note that “sal” is the Latin word for “salt.” This Latin root is tied to the French word “salaire,” which means “salary” in English.
Many centuries later, as trade economies emerged, salary began to more closely resemble what it is today. Salary evolved from a bartering system to workers being paid based on time worked, pieces produced, and fixed amounts.
Over the years, compensation has grown to include both monetary and non-monetary payments.
Other terms similar to compensation that can assist you
- Compensation benchmarking: The matching of internal job descriptions with salary surveys or market pay data to determine the market pay for each position.
- Fair Labor Standards Act (FLSA): A federal law that governs minimum wage, overtime, child labor, and record-keeping rules and regulations for most U.S. workplaces.
- Compensation management: The process of developing, implementing, and managing sound policies, procedures, and practices regarding employee compensation.
- Wages and hours: Refers to the many aspects of employees’ wages and hours worked. The FLSA governs the administration and application of wages and hours. State and local wage and hour laws also govern companies’ pay practices.
- Compensation philosophy: A formal statement documenting the company’s stance on employee pay practices. It addresses the “why” behind the pay program.
- Compensation plan: A formal (written) document describing the company’s position on total rewards provided to employees for services rendered. It addresses the “who,” “what,” “why,” “how much,” and “how often” of employee comp.
Similar Glossary definitions you must know
The process of comparing different aspects of the organization against those of competitor organizations in order to determine performance drivers and areas of improvement.
Salary ranges are built based on how the market pays a group of similarly-skilled jobs.
Encompasses all of an employee’s pay and reward package. Comprises not just salary but also benefits, recognition, incentives, development, and well-being perks.
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Summary of compensation
Compensation is remuneration to an employee for work performed. It includes monetary payments, such as salary, regular hourly wages, and overtime. It also incorporates non-monetary payments, such as health and wellness benefits.
Compensation must be adeptly managed in order to attract, motivate, engage, and retain qualified employees. Otherwise, employee dissatisfaction will set in, and so will turnover. Regulatory compliance is also at stake, as there are many compensation laws that employers must comply with.
The HR team is responsible for ensuring that comp is managed in a way that influences positive business outcomes. For this reason, the HR team must be highly skilled in all facets of compensation management.