After reading this article you will learn about:- 1. Meaning of Compensation 2. Objectives of Paying Compensation 3. Forms 4. Factors 5. Features.

Meaning of Compensation:

Employees work to earn money (wages or salary). This money is broadly termed as compensation. It is the reward they want from management in return for services rendered to the organisation. Compensation or paying employees for their work is an important responsibility of human resource managers. How much compensation a worker wants depends upon his economic needs.

If a man is unemployed and hard pressed, he will be ready to work for lower compensation. If his physiological needs (food, clothing, shelter) are satisfied, he will bargain for better compensation. Good compensation (or pay packet) not only attracts talented employees, it also retains them in the organisation for long run.

The purpose of compensation is, thus, to attract and retain the employees. Organisations have to increase the motivation and commitment of employees to retain their services in the organisation. This can be largely done through the reward system employed in the organisation. This system thus, aims to align individual goals of earning money with organisational goals of meeting its commitments.


“Compensation is a comprehensive term which includes wages, salaries, all other allowances and benefits.” It involves remunerating people for services rendered by them and motivating them to reach the desired level of performance. Compensation may be paid in cash, kind or both.

Paying compensation evolves a system of wages or salaries, their timely payment, job evaluation, individual pay determination, incentive plans etc. The personnel manager should determine compensation in exchange for employees’ services as unbalanced compensation policy can lead to industrial disputes, thus, affecting industrial productivity and profits.

Compensation relates to both financial and non-financial rewards:

1. Extrinsic rewards:


It relates to monetary rewards and incentives such as wages, salaries, bonus, commission, profit sharing etc.

2. Intrinsic rewards:

It is concerned with non-financial rewards that satisfy employees’ psychological needs. These rewards relate to job variety, job challenge, achievement, recognition, opportunities for career development etc.

Objectives of Paying Compensation:

Managers design compensation policies to achieve the following objectives:


1. Attract qualified personnel:

In the competitive business environment, managers pay high compensation to attract qualified personnel. Unless the supply of human resource is more than demand, professionally qualified people do not join organisations that pay low compensation.

2. Retain personnel:

If competing firms offer higher compensation, employees will leave the organisations resulting in high labour turnover. This is costly for organisations in terms of appointing new employees and training them. Compensation should not only attract employees, it must also retain them.


3. Equity in pay:

Compensation must be commensurate with the qualification of employees and with what similar employees are getting in competing jobs.

4. Cost control:

Compensation adds to company’s cost. Proper compensation policies help to maintain control over costs.


5. Avoid legal regulation:

Minimum wages are determined by the Government. A sound wage system should comply with legal regulations for paying wages. It should avoid Government interference.

6. Easy to understand:

The wage system should not be complicated. It should be easily understood by employers and employees.

Forms of Compensation:


There are three forms of compensation:

1. Base or primary compensation

2. Supplementary compensation

3. Incentive or variable compensation


1. Primary compensation:

Primary compensation is paid in the form of salary or wages. Wages and salaries generally mean the same; though conceptually wages are paid for manual work to blue collar workers and salaries are paid for non-manual work to white collar workers.

Primary compensation is the basic pay for various categories of jobs. It determines the scale of pay for different positions of the organisation. It is related to job, job content, job importance and skills required to perform the job. Primary compensation is always paid in cash.

Managers take care of the following factors while determining primary compensation:

(a) Job content, that is, responsibilities of the job.

(b) Power of trade unions to bargain with managers.


(c) Ability of the firm to pay compensation.

(d) Financial position of the firm.

(e) Amount of remuneration paid by similar firms.

(f) Rules and regulations framed by the Government for paying compensation like Minimum Wage Act.

There should be equal pay for equal work. However, workers with different skills, qualifications, training and working conditions are paid according to their relative skills and abilities. When compensation structure is designed, every employee should be convinced that he is paid according to his worth and every employee who is making similar contribution is getting the same compensation. Human resource managers should maintain equity to avoid disparity in compensation and conflict amongst managers and workers.

2. Supplementary compensation:


Supplementary compensation is based on individual output or output of the group. This is additional compensation paid to increase motivation and commitment of the group. Employee profit sharing, production sharing plans, employees equity participation, employee stock option plans etc. determine supplementary compensation. These compensation plans should be flexible in nature.

They represent:

(a) allowances, and

(b) perquisites above the basic salary.

(a) Allowance is a monetary payment which is fixed and pre-determined. It is paid to compensate for certain expenses incurred by employees. However, they are paid irrespective of actual expenditure incurred by them.

Usual allowances paid to employees are:


(i) Dearness allowance (DA):

It is paid to compensate for increase in prices or inflation. The amount of DA depends upon the rate of inflation.

(ii) House rent allowance (HRA):

It is paid to compensate for rent paid by employees for their accommodation.

(iii) City compensatory allowance (CCA):

It is paid to compensate for high cost of living. The amount of CCA varies in different cities. It is more in cities where cost of living is high.


(iv) Transport allowance:

It is paid for commuting journey between residence and place of work. There are a number of other allowances like entertainment allowance, conveyance allowance, daily allowance, risk allowance etc. to compensate for specific expenditures incurred by employees.

(b) Perquisites are benefits attached to a position. They are paid in addition to salary or wages. It is not mere reimbursement of expenditure. It is a personal benefit to employees. Some of the perquisites are: rent free accommodation, car, interest free loan, free meals, medical facility, leave travel concession (LTC), children’s education etc.

3. Incentives or variable compensation:

A good compensation plan both attracts and retains the employees. It provides incentives for good performance and motivates the employees to improve their performance and share organisational profits. Incentives can be monetary and non-monetary.

Human resource manager should consider the following factors while designing the incentive plan:


(a) Performance standards should be set for each individual in consultation with functional head, that is, head of the department.

(b) Performance standards should be linked with organisational goals.

(c) Incentive schemes should be fixed for performance level.

(d) Feedback on individual performance should be obtained to improve the incentive plan.

(e) Plans should be framed in consultation with union leaders.

(f) Budgetary allocations must be prescribed for incentive plans.

(g) They should be flexible.

Factors affecting Compensation:

Compensation is affected by the following factors:

1. Worth of employees:

The ability, qualification, skill and experience of employees affects the wage structure of the company.

2. Contribution by employees:

Employees should positively contribute to organisational goals. How much an employee contributes to organisational goals and how much he can contribute in future affects compensation plan of the firm.

3. Bargaining power of trade union:

Companies whose trade unions are strong usually pay more than companies whose bargaining capacity is low. Trade unions bargain for more wages if workers are skilled and efficient.

4. Demand and supply of manpower:

Demand and supply of manpower also affects wages. If demand for manpower is more than supply, wages will be high and vice versa.

5. Remuneration paid by competing firms:

Firms cannot pay less than what competitors are paying. Compensation has to be commensurate with what other firms in the same industry are paying.

6. Ability to pay:

Wages depend upon ability of the firm to pay compensation. Firms which are economically and technically sound pay good compensation.

7. Cost of living:

Reputed companies want their employees to maintain good standard of living. They pay compensation keeping in view the standard of living. Cost of living index determines their wage structure. Dearness allowance and city compensatory allowance are paid to meet the high cost of living in the city.

8. Government regulation:

Government regulations play important role in fixing the compensation. Minimum Wages Act, 1948, Payment of Wages Act, 1936, Industrial Disputes Act, 1947, Equal Remuneration Act, 1976, Pay Commissions etc. regulate compensation policies of companies.

9. Job evaluation:

Wage determination is largely affected by job evaluation. It determines relationships amongst different jobs in order to establish a systematic structure of wage rates for those jobs. It relates to assessment of the job and not the performance of the person performing that job. This ensures that people doing the same type of work receive equal rewards. Job evaluation measures differences between jobs and places the jobs in different ranks to determine the wage structure for each group or rank of jobs.

Features of a Good Compensation Plan:

A good compensation plan has the following features:

1. It should be simple to understand.

2. There should be equal work for equal pay.

3. It should offer minimum wages and incentives for good performance.

4. It should attract and retain people in the organisation.

5. It should motivate employees to contribute their best to organisational goals by linking wages with output.

6. It should satisfy lower and higher-order needs of the employees.

7. It should maintain balance and harmony amongst managers and workers. Conflicts should be reduced.

8. It must be consistent with what competitors are paying to their employees.

9. It should be consistent with cost of living.

10. It should have incentive schemes so that workers who excel in their performance earn more than their fellow workers.

11. It should have scope for promotions and pay hikes.

12. It must be based on merit and job evaluation of workers.