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What is Meant by Employee Compensation?

Jeremy Cook, Paul Mckinney
  • Author
    Jeremy Cook

    Jeremy taught elementary school for 18 years in in the United States and in Switzerland. He has a Masters in Education from Rollins College in Winter Park, Florida. He's taught grades 2, 3, 4, 5 and 8. His strength is in educational content writing and technology in the classroom

  • Instructor
    Paul Mckinney

    Paul has been in higher education for 17 years. He has a master's degree and is earning his PhD in Community College Leadership.

What is compensation? Understand the meaning of employee compensation in human resource management. Learn how the companies make employee compensation policy. Updated: 12/21/2021

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What is Compensation?

When people go to work every day, they generally don't do it because it's fun; they do it because they get compensated. Working is part of the labor market where employers exchange compensation for work. But what is employee compensation, and is it just another word for wages or pay?

The employee compensation definition is any money or benefits paid to an employee in exchange for work. From the employee's standpoint, compensation is everything that they get for the work they put in. Different businesses compensate their employees in different ways. Some employees earn a wage, and that's all. Other employees earn a base salary and then receive bonuses or commissions. In certain cases, compensation can include things like stock options, company cars, or even housing.

Employee compensation looks slightly different from a Human Resources standpoint. The employee compensation definition in human resource management is a tool that can be used to make the company better and meet its needs. Human Resources uses compensation as a tool to make sure that the company is getting the best candidates, retaining employees, and keeping up internal morale.

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Employee Compensation Components and Examples

When people are paid by their employer, they are done so in different ways and include different things. But when the dust settles, most employee compensation contains one or more of three key components. Some employees only receive one component, while others may receive all three. The three components are fixed income, variable income, and benefits.

Fixed Income

A fixed income is compensation set at a standard rate, and the employee is always paid the same rate. Fixed incomes come in the form of hourly wages, salaries, and contractual wages. The important thing to consider is that fixed incomes will remain the same as long as the employee works the required time. The following are three examples:

  • Bob works at a factory full time and earns $20 an hour. He works 40 hours a week, making a weekly fixed income of $800. If Bob is out sick and doesn't have sick time to use, he will receive less, but his rate is still fixed at $20 per hour.
  • Mallory works for an insurance company as an engineer. She makes an annual salary of $130,000 a year. Her salary is divided into 26 pay periods of $5000 each period. She will get this pay as long as she works and does her job.
  • Kimberly works freelance and is paid a rate of $250 for each project she completes. She gets to pick the projects she wants to work on and the number she wants to complete. She aims to complete three projects a week and earn $750. Unless she chooses not to complete the projects, she will earn her rate.

Variable Pay

Variable pay is when an employee is paid based on commission, sales, or other objectives that change from period to period. The compensation is considered variable because it is based on numbers that can change, and the variations are out of the total control of the employee. The following are some examples.

  • Ted works at a car dealership and earns a sale commission of 5% on the sales price of each car he sells. Different customers buy different priced cars, different months are busier than others, and the total price of vehicles might go lower or higher depending on many facts. This leads to Ted's paychecks being different each time, even if he works the same amount of hours.
  • Bob works freelance for a content development company, and he gets paid different rates depending on what projects he is chosen for. Some months he is very busy and makes well over $4000 and other months he is less busy and makes less than $1500. Because he is assigned the work and the pay varies, his pay is considered variable.

Benefits

Benefits are a part of employee compensation that many people don't think about as part of their actual pay because they don't generally come in the form of monetary compensation. Benefits are a type of compensation that comes in the form of extra perks beyond being paid. The biggest benefit that companies offer in terms of cost to the company and benefit to the employee is health insurance. There are many other benefits and perks that are considered part of a compensation package.

  • Stock options
  • Company vehicle
  • Paid Education
  • Paid Certifications
  • Housing
  • Employee Discounts

The list of potential benefits could be endless, and those benefits depend on many things such as level of employee, industry, experience, and location.

Health care for an employee

An image of a child at the doctors

Employee Compensation Types

The three main categories of compensation are fixed incomes, variable income, and benefits, but under those broad categories, employees might see different specific types of compensation.

Base Pay

When a company lists a salary as a base salary, it generally means that it pays both a fixed income and a variable income. Most positions with a base salary have some sort of variable compensation that is paid above and beyond the base salary. That compensation could be based on sales of the individual employee, the department, or even the company itself. Base pay is very common in sales jobs where the base pay is low, and the employee can increase their salary by increasing their sales.

Commissions

When an employee is compensated based on commission, they are given an agreed-upon rate based on some sort of action of the employee. Most times, a commission is based on sales. An employee might get paid 7% of total sales, for example. Other times the action might be on volume. An employee might be paid a certain amount based on how many items they produce, sell, or ship.

Overtime Pay

Overtime pay is compensation to employees who work more than 40 hours a week. This type of pay can be controversial because it is very hard to monitor beyond workers who are paid by the hour. Hourly employees have to clock in and out, and if their hours go beyond 40, they are paid at a higher rate of pay for the time. Technically salaried employees should fall under overtime rules as well, but since they are not tracked for time, most salaried employees don't get overtime pay.

Bonuses / Profit Sharing

A bonus is a set amount or percentage based on an achieved target or objective. Bonuses are different than commissions because they are usually paid above and beyond an employee's regular salary. Bonuses might be paid on an individual basis for meeting agreed on goals or targets. Some companies give bonuses as a percentage based on overall company performance. Bonuses can also be performance-based on an individual level, where an employee receives a bonus percentage based on their yearly performance evaluation. Bonuses based on performance evaluations are common in positions where the employee cannot meet a specific target.

Profit-sharing is a kind of bonus given to employees based on the performance and profits of the company in a year or a quarter. Profit-sharing is usually a percentage of the profit for the period that is divided across the eligible employees. The bonus from profit sharing will vary once it gets to the individual employee level and is agreed on as part of a compensation package.

Stock Options

One way that a company can compensate its employees is through company stock options. If a company is publicly traded, they can give employees certain shares of the company stack as a part of their compensation package. Stock options are seen as an attractive way to entice employees to perform for the betterment of the company while not having to dole out liquid cash. Stock options can be used in several ways to compensate, such as part of monthly earnings, commission-based, or as a regular or sporadic bonus.

Allowances

Allowances are a compensation method that gives employees money towards work-related expenses like transportation, housing, or food. If a company is in a large city like New York, they may offer a potential employee from outside the city a certain housing allowance to entice them to come and work and live in the city. Transportation allowances give employees money towards transportation costs through reimbursement.

Other Benefits

Most of the other compensation methods beyond the ones described fall into a very broad category known as perks. Perks are something extra and desirable that comes from being in a certain job or position.

  • Freebies - Freebies are given to employees for free simply because they work for the company. They are usually not very valuable but can be uplifting and morale-boosting. Company shirts, stress balls, and other trinkets are considered freebies.
  • Discounts - Discounts are almost always a percentage reduction in a product or service price. Some retailers give up to 50% discounts, and workers for the automotive industry get a generous employee discount on vehicles.
  • Other Perks - Employees of Walt Disney World and Universal Orlando get the perk of free park access all year long. Employers have a vast list of perks they can use to entice employees like secretaries, office equipment, food, car services, wardrobes, and travel expenses.

Importance of Employee Compensation

It might seem silly to have a category dedicated to why compensation is important, but there are some nuances that are important to differentiate and analyze. While the main reason people work is to be paid money, that is not always the chief reason why an employee might leave their position or agree to take a position.

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Frequently Asked Questions

What are employee compensation and benefits?

Employee compensation and benefits are the entirety of compensation that an employee receives in exchange for work. This includes everything from pay to bonuses, health care to perks.

What are some examples of compensation?

Compensation comes in many different forms besides monetary compensation. There are bonuses, stock options, profit sharing, perks, and allowances that are part of a compensation package.

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