Forms of Financial Compensation

Compensation is a monetary benefit given to workers in return for services provided by them and it can take a number of different forms.

Learning Objectives

Explain each part of a total rewards system including salary, benefits, incentive pay, and an employee stock option (ESO)

Key Takeaways

Key Points

  • There are six basic forms of compensation: salary, short-term incentives (STIs or bonuses), long-term incentive plans (LTIPs), benefits, paid expenses, and insurance.
  • Short-term incentives are usually formula-driven, whereas bonuses are awarded after-the-fact and are usually discretionary.
  • Wages are given to workers whereas salaries are given to employees. They are both affected by market forces, as well as other factors, such as tradition, social structure, or government regulation (e.g., minimum wage laws).
  • Executive pay is usually a mixture of these different forms of compensation, with a salary, bonuses, benefits and expenses, and shares or call options on company stock.
  • Salaries are often seen as part of a "total rewards" system that includes benefits and perquisites.
  • Employee stock options (ESOs) are sometimes offered to management, with the objective of giving them an incentive to behave in a way that boosts the company's stock price.

Key Terms

  • salary: A fixed amount of money paid to a worker, usually measured on a monthly or annual basis, not hourly, as wages. Implies a degree of professionalism and/or autonomy.
  • perquisite: Any monetary or other incidental benefit beyond salary.

There are six basic tools of compensation or remuneration:

  • Salary
  • Short-term incentives (STIs), sometimes known as bonuses
  • Long-term incentive plans (LTIP)
  • Employee benefits
  • Paid expenses (perquisites)
  • Insurance

A salary is a form of renumeration paid periodically by an employer to an employee, the amount and frequency of which may be specified in an employment contract. From a business point of view, salary can be deemed as the cost of acquiring human resources for running operations and is then termed personnel expense or salary expense.


Salary: A salary is a form of remuneration paid periodically by an employer to an employee, the amount and frequency of which may be specified in an employment contract.

In accounting practice, salaries are typically recorded in payroll accounts. While there is no first pay stub for the first work-for-pay exchange, the first salaried work would have required a human society advanced enough to have a barter system to allow work to be exchanged for goods or other work. More significantly, it presupposes the existence of organized employers—perhaps a government or a religious body—that would facilitate work-for-hire exchanges on a regular enough basis to constitute salaried work.

Today, the idea of a salary continues to evolve as part of a system of all the combined rewards that employers offer to employees. Salary (also now known as fixed pay) is coming to be seen as part of a "total rewards" system, which includes bonuses, incentive pay, and commissions, benefits and perquisites (or perks), and various other tools which help employers link rewards to an employee's measured performance. An employee stock option (ESO) is a call option on the common stock of a company, granted by the company to an employee as part of the employee's remuneration package.

The objective is to give employees an incentive to behave in ways that will boost the company's stock price. If the company's stock market price rises above the call price, the employee would exercise the option, pay the call price, and would be issued with ordinary shares in the company. The employee would experience a direct financial benefit of the difference between the market and call prices. If the market price falls below the stock call price at the time the option needs to be exercised, the employee is not obligated to call on the option, in which case the option will lapse.

Restrictions on the option (such as vesting and limited transferability) attempt to align the holder's interest with those of the business shareholders. Employee stock options are mostly offered to management as part of their executive compensation package. They may also be offered to non-executive level staff, especially by businesses that are not yet profitable, insofar as they may have few other means of compensation.

Alternatively, employee-type stock options can be offered to non-employees: suppliers, consultants, lawyers, and promoters for services rendered. Employee stock options are similar to warrants, which are call options issued by a company with respect to its own stock.

Pay Systems

Organizations can remunerate labor according to different criteria, including hours worked, output produced, or a combination of the two.

Learning Objectives

Identify the different wage payment systems used by organizations by which they remunerate labor

Key Takeaways

Key Points

  • Under a time rate system, the worker is paid by hour, day, week or month. Under a high wage plan, the worker is paid highly in exchange for a high level of performance.
  • Under a piecework system, the worker is paid according to output. A straight piecework system is completely independent of time taken, whereas a differential piecework system rewards more efficient workers.
  • A combination of time and piecework systems also exist, such as the Gantt Task and Bonus System, and Emerson's Efficiency System (see examples).
  • Under a lockstep compensation system, salaries are based purely on seniority within an organization. This system is easy to administer, but can reduce incentives for employees to perform.

Key Terms

  • contingent worker: a provisional group of employees who work for an organization on a non-permanent basis
  • wage: An amount of money paid to a worker for a specified quantity of work, usually expressed on an hourly basis.
  • remuneration: a payment for work done; wages, salary, emolument

Wage payment systems are the different methods adopted by organizations by which they remunerate labor There exists several systems of employee wage payment and incentives, which can be classified as following:

Time Rate System: Under this system, the worker is paid by the hour, day, week, or month.

High Wage Plan: Under this plan, a worker is paid a wage rate that is substantially higher than the rate prevailing in the area or in the industry. In return, he is expected to maintain a very high level of performance, both quantitative and qualitative.

Measured Day Work: According to this method, the hourly rate of the time worker consists of two parts viz, fixed and variable. The fixed element is based on the nature of the job (i.e., the rate for this part is fixed on the basis of job requirements). The variable portion varies for each worker depending upon his merit rating and the cost-of-living index.

Differential Time Rate: According to this method, different hourly rates are fixed for different levels of efficiency.

Payment by Results Piece Work Straight Piecework System: The wages of the worker depends upon his output and rate of each unit of output; it is in fact independent of the time taken by him.


Piecework system: A family in New York City making dolls' clothes by piecework in 1912. Each family member earns money based on how many pieces they produce.

Differential Piece Work System: This system provides for higher rewards to more efficient workers. For different levels of output below and above the standard, different piece rates are applicable.

Taylor Differential Piece Work System Merrick Differential Piece Rate System Combination of Time and Piece Work Gantt Task and Bonus System: The system consists of paying a worker on a time basis if he does not attain the standard and on piece basis (high rate) if he does.

Emerson's Efficiency System: Under this system, minimum time wages are guaranteed. Beyond a certain efficiency level, bonus in addition to minimum day wages is given.

Renumeration systems are procedures for determining an employee's salary.

For example, lockstep compensation is a system of remuneration in which the employees' salaries are based purely on their seniority within the organization. In the legal profession, where this system is most commonly found, all law school graduates hired by a law firm who graduated in the same year, receive the same base pay, regardless of the background, experience, or ability of each. During the late-2000s financial crisis, some law firms began replacing the lockstep system with "merit-based" systems.The lockstep system of compensation has the benefit of being easy to administer, reducing internal competition within firms, and maintaining a single company philosophy. At the same time, however, it has been criticized for being inefficient and reducing incentives for employees to improve performance.

Standard Benefits

Human resource requisites regarding employee compensation include a wide variety of common benefits beyond salary.

Learning Objectives

List the various standard benefits human resource professionals must take into account when compensating employees

Key Takeaways

Key Points

  • Compensation is more than just salary. Employees require a wide variety of supports in order to work and live comfortably.
  • Benefits are a great source of differentiation and talent recruiting for organizations, as excellent benefits can tip the scales in an organization's favor when negotiating with new potential employees (as well as when trying to retain current talent).
  • Standard benefits can vary fairly widely, but generally revolve around health care, transportation, retirement, various forms of insurance, relocation, dependent support, childcare, and a strong work-life balance.

Key Terms

  • pension: An annuity paid regularly as benefit due to a retired employee, serviceman etc. in consideration of past services, originally and chiefly by a government but also by various private pension schemes.
  • dependent: An individual who an employee supports financially, often a spouse or a child.

Compensation incorporates more than just salary, and benefits are a key legal, motivational, and organizational consideration when it comes to employee relations. Organizations provide a wide range of benefits for employees, and understanding what can be expected as a new employee is an important aspect of negotiation.

Standard Benefits

Standard benefits span a wide variety of employee needs, and represent a key reason for employees to find full-time employers who provide a full selection of standard benefits. Human resource professionals must familiarize themselves with the organizational offerings revolving around:

  • Relocation assistance - Often enough, hiring employees requires some percentage of those employees to move from one location to another. Talent is found all across the globe, and motivating talent to come to you requires assistance with visas, housing, flights, and a wide variety of other costs.
  • Medical, prescription, vision and dental plans - Particularly in countries with poor social benefits, medical insurance is a requisite for hiring full-time talent (sometimes even legally required). In socially supportive countries, these benefits are provided by the government as a basic need.
  • Dependent care - Just as noted above regarding health insurance, many working professionals have individuals who are dependent upon them (spouses and children primarily). These individuals are covered under group health insurance plans for that given employee.
  • Retirement benefit plans ( pension, 401(k), 403(b)) - Employees are entitled to various retirement-related benefits such as long-term investments, pensions, and other savings for retirement age. The primary draw for most of these benefits is the tax benefits, whereas withdrawing this capital past the retirement age is tax free.
  • Group-term life and long term care insurance plans - Life insurance and long-term care are benefits paid by employers to insure individuals against various types of risks and disasters. Employees with life insurance or long-term care insurance will see their dependents (and themselves, in the case of long-term care) supported if a serious ailment or tragedy occurs.
  • Legal assistance plans - Not quite as standard as the rest of the benefits above, legal assistance plans can be put in place for jobs where personal liability is high. Legal assistance is expensive, and in circumstances where legal assistance is in place the employee will be covered by organizational resources.
  • Child care benefits - Supporting employee families is absolutely critical to retaining great talent. With two working parents being quite common, having childcare options in place for employees is a key benefit, allowing parents to focus on their work (not to mention the huge cost savings of group plans via an organization).
  • Transportation benefits - Another common benefit is paid transportation. Particularly in countries/regions where public transportation is the norm (as opposed to personal vehicles), it's quite common for the employer to pay for all work related transportation.
  • Paid time off (PTO) in the form of vacation and sick pay - All organizations must provide paid time off, vacation, and sick pay in certain circumstances. Many countries have stringent legislation governing minimum requirements for paid time off and vacation leave to ensure the people in that country have a healthy working environment.

While there are other, less common benefits that can be provided, this list is a comprehensive overview of what employees can normally expect from employers in regards to standard benefits of employment.

Fringe Benefits

Fringe benefits are various indirect benefits, often of a more discretionary nature than standard benefits.

Learning Objectives

Explain fringe benefits

Key Takeaways

Key Points

  • The term was coined during World War II to describe the various indirect benefits which industry had devised to attract and retain labor when direct wage increases were prohibited.
  • Companies that offer such work-life perks aim to raise employee satisfaction and thus corporate loyalty.
  • Certain fringe benefits may be excluded from an employee's gross income and are thus not subject to federal income taxes. An example of this is flexible spending accounts, 401(k), and 403(b). Accident, health, and life insurance plans also act in this way.

Key Terms

  • tax shelter: A legal structure that reduces tax liability for a person or that person's assets.
  • 403 (b): A U.S. tax-advantaged retirement savings plan available for public education organizations, some non-profit employers, cooperative hospital service organizations, and self-employed ministers in the United States. It has tax treatment similar to a 401(k) plan.
  • 401(k): 401(k) are "defined contribution plans" with annual contributions limited (currently to $17,000). Contributions are "tax-deferred" in that they are deducted from paychecks before taxes and then taxed when a withdrawal is made from the 401(k) account. Depending on the employer's program, a portion of the employee's contribution may be matched by the employer.

The term "fringe benefits" was coined by the War Labor Board during World War II to describe the various indirect benefits which industry had devised to attract and retain labor when direct wage increases were prohibited. The term perks (also perqs) is often used colloquially to refer to those benefits of a more discretionary nature.

Perks are often given to employees who are doing notably well or have seniority. Common perks are hotel stays, free refreshments, leisure activities on work time, stationery, allowances for lunch, and take-home vehicles. When multiple choices exist, select employees may also be given first choice on such things as job assignments and vacation scheduling. They may also be given first chance at job promotions when vacancies exist.


Company Car: One of the perks this lifeguard enjoys is the use of a company car.

Benefits may also include formal or informal employee discount programs that grant workers access to specialized offerings from local and regional vendors (e.g., movies and theme park tickets, wellness programs, discounted shopping, hotels and resorts, and so on). Companies who offer these types of work-life perks seek to raise employee satisfaction, corporate loyalty, and worker retention by providing valuable benefits that go beyond a base salary figure.

Some fringe benefits (for example, accident and health plans, and group-term life insurance coverage up to US $50,000) may be excluded from the employee's gross income and are therefore not subject to federal income tax in the United States. Some function as tax shelters (for example, flexible spending accounts, 401(k),and 403 (b)). Fringe benefits are also thought of as the costs of keeping employees other than salary. These benefit rates are typically calculated using fixed percentages that vary depending on the employee's classification and often change from year to year.

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