Compensation refers to the remuneration that an employee receives in return for his/her services to the organization.

Compensation management is an integral part of human resource management and helps in motivating the employees and improving organizational effectiveness.

Compensation is a comprehensive term which includes everything an employee receives in return for his work such as wages, salaries, allowances, benefits and services.

Although there is no basic difference between the term ‘wages’ and ‘salaries’, generally ‘salary’ is used for compensation to white-collar employees while ‘wages’ is used to denote the payment made to blue-collar workers. Another difference is that salaries are paid on a monthly basis whereas wages may be paid on hourly or daily basis.


Learn about meaning and definition of compensation.

Additionally, learn about the perception and nature of compensation.

Compensation Meaning in HRM

Meaning of Compensation in HRM

Compensation refers to the remuneration that an employee receives in return for his/her services to the organization. Compensation management is an integral part of human resource management and helps in motivating the employees and improving organizational effectiveness.

In organizations, determining the rates of monetary compensation is by far the most difficult func­tions of human resource management. It is not only complex, but significant both to the organization and its employees. Employee compensation decisions are crucial for the success of an organization. From a cost perspective, effective management of employee compensation is critical because of the existence of total operating costs.


Another reason for studying compensation from the organization’s perspective is to assess its impact on a wide range of employee attitudes and behaviours and, ultimately the effectiveness of the organization and its units. Some of the organizational outcomes such as job satisfaction, attraction, manpower retention, job performance, skill acquisition, cooperation, and flex­ibility are directly influenced by compensation.

At present, in any organization, compensation management is a strategic issue. Employee compensa­tion includes all forms of payments and rewards given to the workforce. Compensation includes both direct financial payments as well as indirect financial payments which employees receive during their tenure of employment. A sound compensation management system is the key driver of motivation, employee retention, and enhanced quality of work life.

The term compensation refers to reimburse­ment, disbursement of incentives, and a strategic issue with regards to salary and wage administration. Direct financial payments include pay in the form of salary, wages, incentives, commissions, and bonuses. Indirect financial payments are given in the form of insurances.

Human resource is the most vital resource for any organization. Like every other function, it also needs to take care of the remuneration and compensation of every employee to get the best out from them. It is needless to mention that lucrative compensation will also serve the need for attracting and retaining the best employees. Now, one needs to understand executive compensation and strategic compensation.


Compensation strategies and systems have undergone rapid changes over the years. Employees were quite happy to receive their salary along with moderate incentives in traditional organisations. They simply had to obey commands, execute managerial orders, and produce results in order to job-related benefits.

Their expectations were also not very high. The behavioural scientists have changed the scenario completely. The Industrial revolution made the work monotonous, boring and highly taxing.

Workers were treated like inert instruments in the production process. The work spot was devoid of life. The need for interaction, interpersonal communication, social networking, happy peer group relations and continual informal exchange of notes was being realised. Man does not work for money alone. Social, and love needs are equally important. It is not the employer who alone would have the final say in deciding the compensation package.

Work groups also come to play a significant role in getting what they want in the form of wages, incentives, rewards and benefits. Remuneration must be in sync with what competitive firms’ pay and in line with the labour market conditions. This trend picked up speed in early 1990s.


Rapid technological changes have compelled many a firm to go in search of talent. Firms have also realised that they need both the will and the skill of employees to stay ahead of competition.

As a result, the need for meeting the growing expectations of workers possessing requisite knowledge, skills and experience was also being increasingly realised. With the entry of global majors companies have realised the need to move closer to the hearts of employees in order to remain competitive. Attractive compensation packages have become the order of the day.

Monetary and non-monetary rewards greet knowledge workers everywhere. Allowances, bonuses, commissions, special benefit packages, attractive stock options have gained popularity. The strategic role of human beings in converting corporate rhetoric into concrete reality has also been recognised. Without active participation and enthusiastic co-operation of employees, it is virtually impossible for organisations to meet their professed goals.

This is the crux of the problem nowadays, as far as compensation is concerned. How to meet the ever rising expectations of workers while simultaneously trying to contain the costs? How to stay lean, fit and agile in a situation where every firm had to fight a relentless war in order to attract and retain talent?


Employees receive compensation in the form of remuneration — monetary rewards as well as non-financial rewards — for services rendered. Compensation is an essential tool to motivate people to superior performance. Without getting paid adequately, employees would be unenthusiastic about putting their heart and soul into organisational work. They may not be inclined to give their best to the organisation.

In most cases, compensation is an important issue affecting how and why employees choose to work at one organisation over others. To attract and retain talent, appropriate compensation plans must be put in place. At the same time, the organisation must keep the labour costs under control.

It must keep the competitive pressures in mind while trying to go overboard while hiring people. It must balance each of these concerns while trying to keep its house in order.

The term ‘Wage and Salary Administration’ refers to the establishment and implementation of sound policies and practices of employee compensation. It includes such areas as job evaluation, surveys of wage and salaries, analysis or relevant organisational problems, development and maintenance of wage structure, establishing rules for administering wages, wage payments incentives, profit sharing, wage changes and adjustments, supplementary payments, control of compensation costs and other related items.


The wage and salary administration is concerned with the financial aspects of needs, motivation and rewards. Managers, therefore, analyse and interpret the needs of their employees so that reward can be individually designed to satisfy these needs. For it has been rightly said that “people do what they do to satisfy some need. Before they do anything, they look for a reward or pay-off.”

Executive Compensation:

Executive compensation has become a topic for hot discussion, immediately after the collapse of giant corporations like Satyam Computers, Enron, WorldCom, Tyco, etc. Top executives, in each of these cases, have taken the companies for a joy ride. By converting stock options — granted even when the companies were making losses — into stock and selling the same in open market, these executives have made millions at the cost of ignorant shareholders.

They have also diverted the funds belonging to shareholders for private ends. Window dressing of balance sheets seems to be a routine affair. Virtually throwing mud on the faces of gullible shareholders, the top executives have eaten away the vitals of the company by spending scarce corporate resources with reckless ease — that too, without any fear of punishment.


They seem to have scant respect for the rule book. They have thrown caution to the wind and tried to cut corners whenever the opportunity arose. When the scams broke out with frustrating regularity, everyone is forced to ask the question- how to arrest the menace and put things in order?

Meaning of Compensation in HRM  – Definition by Cascio

The term ‘compensation’ is an all-embracing word that comprises different forms of payment and rewards provided to employees for performing various tasks that lead to the attainment of organizational objectives. Compensation signifies an exchange relationship between the employer and the employee. It determines the standard of living and purchasing power.

While employees seek to maximize their reward to meet their aspirations, the employer seeks to minimize it to the extent possible to cut down the cost of operation thereby enhancing their profit. At the same time, there is a conviction that the compensation and reward can influence desirable work behaviour of employees. Thus, compensation serves several objectives not only for the organization but also for the employees.

Compensation or reward is an important aspect of human resource management. It is a key driver of an individual worker’s choice of employer. Employee’s perception of the inadequacy of organizational rewards is an important determinant of their satisfaction and consequent performance.

The literal meaning of compensation is to counter-balance. In the case of human resource management, compensation is referred to as money and other benefits received by an employee for providing services to his employer.

Money and benefits received may be in different forms base compensation in money form and various benefits, which may be associated with employee’s service to the employer like provident fund, gratuity, insurance scheme, and any other payment which the employee receives or benefits he enjoys in lieu of such payment.


Cascio has defined compensation as follows:

Compensation includes direct cash payments, indirect payments in the form of employee benefits, and incentives to motivate employees to strive for higher levels of productivity.

Determination of suitable monetary compensation is one of the most difficult and complex duties of human resource manager. It is highly important to both the organization and employee. It is significant for the employee as, in most cases, it is the only means of economic survival besides determining their social status.

It is important for the organization as wages and salaries constitute the highest cost of doing business. Also, employee compensation programmes play an important role for organization in attracting, motivating and retaining the competent employees. There are many options before an organization from which it has to decide most appropriate pay system.

There is no exact and accurate yardstick that can determine the correct pay rate. Although systems like job evaluation play a significant role, yet lots of other factors have to be considered to arrive at the best decisions.

Employee compensation refers to all forms of pay or rewards going to employees and arising from their employment. Employee compensation has three main components and the relative proposition of each component in the total compensation varies by the organization.


Components of compensation are:

(i) Base compensation.

(ii) Incentive payments.

(iii) Benefits and services.

Compensation is a comprehensive term which includes everything an employee receives in return for his work such as wages, salaries, allowances, benefits and services. Although there is no basic difference between the term ‘wages’ and ‘salaries’, generally ‘salary’ is used for compensation to white-collar employees while ‘wages’ is used to denote the payment made to blue-collar workers. Another difference is that salaries are paid on a monthly basis whereas wages may be paid on hourly or daily basis.

Meaning of Compensation in HRM – How is Compensation Used?

‘Compensation means different components or the total of all forms of payments and rewards given to employees for performing tasks to achieve organisational goals.’ It is an important determinant of employees’ satisfaction and subsequent their performance.


Within the dynamic HR practices, compensation and rewards management is a decisional and complex process and it involves the design, formulation, development, communication, implementation and evaluation of compensation system process and strategies in the organisation.

Compensation and rewards offered by an organisation is an important determinant of an individual’s performance, decision to join a company, motivation to improve performance, desire to undergo training and to continue to work for the organisation. Organisations also view compensation and rewards as a means to reinforce desirable employee behaviour.

Compensation and rewards plays an important and decisional role in any organisation. Employees expect to be fair rewarded by the organisation for their contribution. It is the foremost part and key reason of organisation that an employee chooses to work for one organisation and not for another.

“If you pick the right people and give them the opportunity to spread their wings and put compensation and rewards as a carrier behind it – you almost don’t have to manage them “. -Jack Welch

Compensation is any form of payment given to the employees in exchange for the work they perform. Financial payment made at or near place where work is performed is called “Direct Compensation” (e.g. – Wages, Salaries, Overtime Pay, and Commissions/Incentives and Bonuses).

Compensation is a systematic approach to providing monetary value to employees in exchange for work performed. Compensation may achieve several purposes assisting in recruitment, job performance and job satisfaction.


Remuneration is the compensation an employee receives in return for his or her contribution to the organization. An employee’s standard of living, status in the society, motivation, loyalty, and productivity depends upon the remuneration he or she receives from an organization.

How is Compensation Used?

Compensation is a tool used by management for a variety of purposes to further the existence of the company. Compensation may be adjusted according the business needs, goals and available resources.

Compensation may be used to:

a. Recruit and retain qualified employees.

b. Increase or maintain morale/satisfaction.


c. Reward and encourage peak performance.

d. Achieve internal and external equity.

e. Reduce turnover and encourage company loyalty.

f. Modify (through negotiations) practices of unions.

Meaning of Compensation in HRM – According to Edwin B. Flippo

Compensation is perhaps the most important element in a human re­source management program. It is one of the most sensitive issues for an organisation as majority of the employees in the organisation join a particular organisation mainly for the compensation offered by them. Salary is an important component for an employee as it determines their purchasing power and economic status in the society.

Compensa­tion is an equally important matter for the organisation because wages and salaries often constitute the greatest single cost of doing business. The selection of a compensation plan which meets both company’s objective and motivational needs of employees is often as difficult as selecting a good employee – and is just as important.

According to Edwin B. Flippo (1984), as far as the organisation is con­cerned, employee compensation programs are designed to do three things:

1. To attract capable employees to the organisation;

2. To motivate them towards superior performance;

3. To retain their services over an extended period of time.

As we have gathered till now that selecting an employee is a very diffi­cult job, retaining an employee is rather a more difficult job. This is where the compensation and a salary program of the organisation play a very important role. Majority of the people these days apply for a job in a particular organisation only after having a look at the package be­ing offered by that organisation.

So the organisations should carry out the job evaluation carefully and designing the compensation programs attractively. Employees continuously need to be motivated towards superior performance with the help of various financial as well as non-financial incentives.

It is always in the interest of the organisation to cultivate a loyalty amongst their employees as this will reduce the employee’s turnover in the long run and will add to their credibility.

Meaning of Compensation in HRM

Compensation is an important element in HRM as it is the responsibility of every organization to offer optimum wages and salaries to employees for keeping them motivated to work in the organization. Compensation varies according to the nature of job, skills required for the job, and the risk associated with the job. It is paid in the form of wages, salaries, and benefits.

Compensation can be defined in the following ways:

i. Compensation includes both monetary and non-monetary rewards offered to employees by their employer in return of their services.

ii. Compensation means pay in return for work done by employees.

iii. Compensation is the sum total of the benefits in monetary or non-monetary form received by an employee in return of his/her work effort.

Wage determination is difficult as there are various factors and guidelines that have to be discussed before determining the wages.

These factors are explained in the following points:

i. Supply and demand of labor – Forms one of the major determinants of compensation. If the demand of labor is more than its supply, the wage rates increase. On the other hand, if the demand for labor is less than its supply, the wage rates decrease.

ii. Ability to pay – Refers to the financial position of the employers and their willingness to pay to the employee. This factor indirectly determines the financial health of the organization.

iii. Productivity of workers – Refers to the maximum output that workers produce on an average according to their efficiency to perform. Productivity based wages have come into picture as a tool for increasing the motivation level of workers.

iv. Cost of Living – Refers to an index that measures the cost of standard of living, thus, works as a determinant of wage rates. The cost of living index can bring variation in the wage rate. If the cost of living is high, it will lead to higher wages and salaries.

v. Government Laws – Refer to various laws regarding wages and salaries as well as minimization of exploitation of workforce. These laws try to bring equity and fairness in wage payment throughout the industry.

vi. Wage Rates – Refer to the wages earned per unit of time or output, which are determined by the current wage level that exists in the industry. In order to achieve both external as well as internal equity, wage rates must be decided in accordance with the competitors’ wage levels.

Meaning of Compensation in HRM – With Perception and Nature of Compensation

Compensation means something given to compensate the loss. An employee gives his valuable time for the management by his physical technical and intellectual knowledge to the employer for his benefits. In lieu, the employer gives him the wage or salary. Wage and salary represent a major part of cost incurred by the organisation. Therefore management of the same need to be in proper manner. It is of paramount importance to any business organisation.

Need of a proper system of compensation in an organisation is very essential. Compensation is a wide range of financial and non-financial rewards or payments. Performance evaluation is the most important basis for determining the level of compensation of individual employee. Compensation payable to employees should be equitable.

Perceptions about the Word “Compensation”:

Perceptions about the word “compensation” or its definitions differ from country to country as well as within one country itself. So far rewards for physical efforts have been learned as ‘Wage’ to workers and compensation for mental & physical efforts at clerical/staff levels as ‘Salary’.

In different countries, its meaning or the inclusions of components of compensation may sometimes confuse the purpose and objectives of compensation management. Brief discussions are, therefore, necessary to highlight these issues.

Nature of Compensation:

The nature of compensation may be a monetary gain or in kind so as to satisfy the employee for his/her worth.

Compensation which includes financial rewards as well as benefits may come in form of:

(a) Basic Pay to match the job specification and description,

(b) Variable Pay to link it with extra work or better performance, and

(c) Benefits to boost the morale and provide comfort as rewards to loyalty.

Wages/salaries are the earnings for the livelihood of an individual, which relieve him/her from financial worries and enable him/her to maintain his/her life style. Perhaps this is the reason why they put in their best efforts to earn more in order to justify their worth and move higher and higher to enjoy a better life and comfort.

In economic terms, wage/salary is a factor of production, a means of increasing earning, and the saving and purchasing power of the people of a locality /state/ region/state or a nation.

In a society, compensation classifies the category or status of an individual, which is related to social development, and psychologically satisfies the needs of an earning member.

A good and proper system of compensation is provided to achieve the following points:

a) To attract capable employees

b) To motivate employees for excellent performance, and

c) To retain them over extended period of time.