Compensation and Pay for Performance

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9.1 What Is Compensation? Compensation consists of three main components. Direct compensation encompasses employee wages and salaries, incentives, bonuses, and commissions. Indirect compensation comprises the many benefits supplied by employers, and nonfinancial compensation includes employee recognition programs, rewarding jobs, organizational support, work environment, and flexible work hours to accommodate personal needs. See Figure 9.1.

Figure 9.1

Compensation Components

The way these three components of compensation are allocated sends a message to the employees about what management believes is important and the types of activities it encourages. Furthermore, for an employer, compensation constitutes a sizable operating cost. Ravin Jesuthasan, compensation specialist at Towers Perrin, notes, “Labor costs are a significant portion of expenses for any organization and a very substantial portion for some, but companies continue to spend on pay programs without any evidence of business relevance.” This means that compensation should be managed strategically

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to ensure that costs are kept down while employee motivation and performance are kept up. Achieving such a balance is no easy task.

In this chapter, we will help you learn how to strategically align the three aspects of compensation with an organization’s objectives, design a pay mix based on the compensation strategy, implement the mix using a series of pay tools, and assess the compensation system using a scorecard. We will also discuss how government regulation might influence these decisions about compensation. See Figure 9.2 for details. In Chapter 10 we will review financial incentive plans for employees. Employee benefits that are part of the total compensation package are discussed in Chapter 11.

Figure 9.2

Compensation Alignment

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