Dr. Vera Petrovna Butkouskaya



Topic 2.5 – Compensation


  • 1. Managing Compensation 

  • 2. Designing a Compensation System 

  • 3. Pay-per-performance 

  • 4. Designing and Administering Benefits 

  • 5. Legal Environment 

1. Managing Compensation

What is Total compensation? Total compensation is the package of quantifiable monetary rewards an employee receives for his or her labour.

The Elements of Total Compensation:
●  Base Compensation,
●  Pay Incentives,
●  Indirect Compensation/Benefits

Base compensation
 or Fixed Pay is the payment an employee receives on a regular basis, either in the form of a salary or as an hourly wage (for example, a weekly or monthly paycheck).
Pay-Per-Performance or Variable Pay
 is a program designed to reward employees for good performance (including bonuses and profit-sharing).
Indirect Compensation or Benefits
 (for example, health insurance, vacations, and unemployment compensation).

Additionally, to Total Compensation (monetary) the company can also apply non-monetary Rewards to motivate employees (such as contacts, recognition programs and career opportunities).

Challenges of Managing Compensation:

  • How to optimize the company’s costs but get adequate performance?
  • How to motivate employees for better performance?
  • How to rich the balance between employee dedication and compensation (internal and external equity)?
  • How to increase job satisfaction and reduce turnover?

Thus, developed correctly, the Compensation System includes Monetary Total Compensation and non-monetary Total Rewards. The synergy of monetary and non-monetary compensations help the company to find a balance between expected performance and cost optimization, from one side, and employee work-life balance and motivation, from the other side.

Compensation system

There are several factors which may determine the Compensation Plan for the specific job position, such as level of responsibility, strategic relevance, the ration demand/supply in the market, cost of living for international HR, tenure or the longitude of an employee working in the company, etc.

Factors Determining Compensation

2. Designing a Compensation System

  • While designing a Compensation System, the company take into consideration the 9 Criteria major criteria:
    1. Internal Vs. External Equity
    Will the compensation plan be perceived as fair within the company, or will it be perceived as fair relative to what other employers are paying for the same type of labour?
    Fair-pay is a payment that employees generally view as equitable based on:
    ● internal equity -the perceived fairness of the pay structure within a firm.
    ● external equity – the perceived fairness in payment relative to what other employers are paying for the same type of labour.fair pay

THE DISTRIBUTIVE JUSTICE MODEL (input/outcome ratio) states that employees exchange to the firm :

  • ○  their contributions or input (skills, effort, time, etc.)
  • ○ for a set of outcomes 
or outputs (compensations from the firm)
    • (1) analysing their own input/outcome ratio
    • (2) comparing this input/outcome ratio with that of other employees within the firm whose job demands are similar to their own.

fairly paid is 
when –> employee’s input/outcome ratio = other employees input/outcome ratio

the labour market modelTHE LABOR MARKET MODEL states that:
●  the wage rate for any given occupation
●  is set at the point where
●  the labour supply = the labour demand
●  in the marketplace.

This means that in the majority of situations:

  • Low demand for labour → fewer employers is willing to pay to → lower the pay workers are willing to accept for a given job
  • High supply of labour → lower the wage rate for that job.

2. Fixed Vs. Variable Pay

  • Will compensation be paid monthly on a fixed basis
  • Will it fluctuate depending on pre-established criteria?


  • a fixed basis—through base salaries
  • a variable pay – payment depending on performance or company profits

fixed pay as a percentage of total compensation continues to decline, and firms are asking employees to share more risks with them

3. Performance Vs. Membership

  • Will compensation emphasize performance and tie pay to individual or group contributions? – Progress by doing a job better(performance concept)
      • OR 

  • Will it emphasize membership in the organization—logging in a prescribed number of hours each week and progressing up the organizational ladder? – Progress by moving up in the organization (membership concept)

In the majority of the situations, the performance concept is applied in flat organizational structures with expert career passes (is represented as a round).  While the membership concept is more common in hierarchical organizations with management careers (is represented as a triangle).

performance vs. membership

4. Job Vs. Individual Pay

  • Will compensation be based on how the company values a particular job position? – it means that all job positions will the same title will have equal payments (for ex., all cooks in pizzeria get the same per-hour payment)
    • OR
  • Will it be based on how much skill and knowledge an employee brings to that job? – it means the “more hats an individual worker can wear”, the more pay he or she will receive (for ex., the cook who has studied at Michelin chef school get an extra payment if to compare to other cooks in a pizzeria).

The job-based compensation plan can be applied:
(1) to achieve internal equity – the comparative relative value of jobs throughout the firm,
(2) to achieve external equity  – salary data comparative to a benchmark,
(3) to achieve individual equity –  an individual’s positioning of his/her experience, seniority, and performance established within the pay range.

A job-based policy better when:

  • ●  Technology is stable.
  • ●  Jobs do not change often.
  • ●  Employees do not need to cover for one another frequently.
  • ●  Much training is required to learn a given job.
  • ●  Turnover is relatively low.
  • ●  Employees are expected to move up through the ranks over time.
  • ●  Jobs are fairly standardized within the industry.

Individual  Pay plan rewards employees for acquiring  

  • depth skills (learning more about a specialized area), 
  • horizontal or breadth skills (learning about more areas),
  • vertical skills (self-management ).

Knowledge/skills based-pay plan has the following advantages and disadvantages:

      • (+) Greater motivation
      • (-) higher labour costs
      • (+) Reduces turnover
      • (-) loss of labour specialization
      • (-) difficulties in selection
      • (-) chaotic workplace

Individual-based compensation better when:

  • ●  The firm has a relatively educated workforce with both the ability and the willingness to learn different jobs.
  • ●  The company’s technology and organizational structure change frequently.
  • ●  Employee participation and teamwork are encouraged throughout the organization.
  • ●  Opportunities for upward mobility are limited.
  • ●  Opportunities to learn new skills are present.
  • ●  The costs of employee turnover and absenteeism in terms of lost production are high.
  • ●  Individual-based pay plans are common in manufacturing environments that rely on continuous-process technologies.

5. Egalitarianism Vs. Elitism

  • Egalitarianism vs. Elitism Will the compensation plan place most employees under the same compensation system (egalitarianism)?
      • OR
  • Will it establish different plans by organizational level and/or employee group (elitism)?

An egalitarian pay system is a payment plan in which most employees are part of the same compensation system. Egalitarianism (+) (common for older, well-established firms)
●  more flexibility to deploy employees in different areas without having to change their pay levels.
●  reduce barriers between people who need to work closely together.

An elitist payment system is a payment plan in which different compensation systems are established for employees or groups at different organizational levels. Elitist pay structures (+) (common and risky and high competition 
environment, high-tech products)
● more stable workforce

6. Below-Market Vs. Above-Market Compensation

Will employees be compensated at below-market levels, at market levels, OR at above-market levels?

To hire the “cream of the crop” – above-market

Company may apply different policy for different Job positions depending, for example, on the strategic relevance. Also, the decisions can be combined with other criteria, for example, market-median based salary with aggressive incentives to give extra value to the job offer. 

7. Monetary Vs. Nonmonetary Awards

  • Will the compensation plan emphasize motivating employees
 through monetary rewards like pay and stock options?
  • Will it stress non-monetary rewards such as interesting work and job security? for ex., “family-friendly policies” or “work-life balance programs”

The organization should be realistic regarding the costs issues and search for the balance between monetary and non-monetary rewards.

8. Open Vs. Secret Pay

  • Will employees have access to information about other worker’s compensation levels and how compensation decisions are made (open pay)?
        • OR
  • Will this knowledge be withheld from employees (secret pay)?

open pay:

  • (+) force managers to be more fair and effective in managing compensation
  • (+) reduce dissatisfaction as employees tend to overestimate the pay of coworkers and superior

secret pay:

  • (+) help managers to avoid arguments with employees

9. Centralization Vs. Decentralization of Pay Decisions

  • Will compensation decisions are made in a tightly controlled central location?
      • OR
Will they be delegated to managers of the firm’s units/department? – for example, is the pizzeria chain it may be done by the manager of each restaurant individually

Summary. Compensation is a complex topic that has a significant impact on organizational success.
●  None of the options is a simple either/or decision
●  Many possibilities between them are possible.

3. Pay-per-performance

Pay-per-performance is a system that compensates employees on the assumptions that:

  • Individual employees and work teams differ
  • Overall performance depends on the performance of the individuals
  • To attract, retain and motivate high performers employees should be 
rewarded based on their relative performance

Types of incentives:

  • ● the piece-rate system is a compensation system in which employees are paid per unit produced.
  • ● the merit pay
 is an increase in base pay, normally given once a year.
  • ● the bonus program
 is a financial incentive that is given on a one-time basis and does not raise the employee’s base pay permanently.
  • ● the award 
a one-time reward is usually given in the form of a tangible prize.
  • ● etc.

Pay-for-performance plans can be designed to reward the performance of the individual, team, business unit or plant, an entire organization, or any combination of these.

pay-per-performance plans

Advantages and Disadvantages of Individual- and Team-Based Pay-for-Performance Plans

Pay per performance

Conditions That Favour Various Pay-Per-Performance Plans

Pay per performance

The Challenges of Pay-Per-Performance plans:
● The «Do Only What You Get Paid For» syndrome (employee focus only on the rewarded objectives)
● Unethical Behaviors («white lies» to «meet or exceed» targets)
● Negative effect on the Spirit of Cooperation (internal competition effect on communication)
● Lack of Control (factors beyond an employee’s control, or employee overloaded)
● Difficulties in Measuring Performance (individual contribution of the group work)
● Psychological Contracts (damaging results of changes)
● The Credibility Gap (fairness of the reward)
● Job dissatisfaction and Stress (greater productivity – more work)
● Potential Reduction of Intrinsic Drivers (no motivation to work without reward)

Meeting the Challenges:
Opportunity to align employees ́objectives with the organization
●  Link Pay and Performance Appropriately (piece-rate system*)
●  Use Pay for Performance as Part a Broader HRM System (for example with training)
●  Build Employee Trust (managers need to show that they care about employees)
●  Promote the Belief that Performance Makes Difference
●  Use Multiple Layers of Rewards (variable pay)
●  Increase Employee Involvement (in the design of the pay system)
●  Stress the importance of Acting Ethically (training programs ‘how to meet performance 
●  Use Motivation and Nonfinancial Incentives (balance – public and nonpublic praise, honorary titles, mentoring programs, expanded job responsibilities, etc.)

Pay-for-performance plans in small firms are more likely to be successful if
there is active employee participation in the development of 
the plan, incentives are linked to the achievement of organizational 
goals, and frequent informal feedback is provided to employees.

4. Benefits, or Indirect Compensation

Benefits are group membership rewards that provide security for employees and their family members. Indirect compensation is given to the employee in the form of plan (health insurance) rather than cash).

Types of Benefits
Legally required benefits 
(1) Social Security, (2) workers’ compensation, (3) unemployment insurance, and (4) family and medical leave.
Other benefits types: Health insurance, Retirement, Insurance, Paid time off, Employee services

Challenges in Managing Benefits:

  • (1) give employees meaningful benefit choices that match their needs,
  • (2) keep the costs of these benefits under control,
(3) ensure that employees are fully informed of their benefit options.

The Benefits Strategy
The design of a benefits package should be aligned with the business’s overall compensation strategy. The benefits strategy requires making choices in three areas:
○  (1) benefits mix,
○  (2) benefits amount, and
○  (3) flexibility of benefits.

HR specialist and Manager’s roles in Managing Benefits:
●  HR staff administrate and control benefits programs:
○  the use of flexible benefits mix
○  Communicating benefits to employees
●  The manager should be familiar with benefits:
○  to employees (help to understand and make the best from benefits)
○  a powerful recruiting tool (use benefits advantage to recruit high-quality applicants) 
 ○  retain talented employees (reduce turnover)
○  a part in managerial decisions and organizational processes (effectively manage work schedules)
○  to managers (to be aware of their own benefit)

5. The Legal Environment and Compensation

legal compensationLabor Standards and Legal Issues

  • MINIMUM WAGES: minimum and average wages
  • OVERTIME: payment for overworking
  • CONTRACT: as a written document
  • SALARY TAXES: social insurance, pension and pay tax
  • others specified in Labour Law


Great Place to Work GPTWGPTW

1. When your business is a great place to work, employees give 100% in everything they do.
2. … you become an employer of choice.
3. … employees think like owners.
4. … customers notice and come back again and again.
5. … absenteeism nearly disappears
6. … turnover costs plummet
7. … collaboration and creativity thrive
8. … you’re impacting the lives of people.