Employee Compensation Tutorial

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In this guide, you will learn a lot about employee compensation including 1) why employees are valuable for a business, 2) how employee compensation and employee benefits are related, 3) laws governing employee compensation, 4) factors affecting employee compensation, 5) the importance of a well-designed employee compensation plan, and 6) the basic components of employee compensation.


Manpower is one of the most important assets of an organization. After all, if you look at the definition of an “organization”, it is said to be composed of a group of people working together towards a common goal or purpose.

Therefore, an organization cannot exist without people. A business cannot hope to survive, much less thrive, without its employees or workers. To assume that having top management is enough to make a business or organization operate smoothly is wrong on so many levels, because they are completely ignoring the company’s best asset: its employees.

It is the employees’ performance that will determine the organization’s or company’s chances of achieving its short-term and long-term goals. If it ultimately wants to be profitable, or if its goal is growth and expansion, then the employees should put in a very good performance – one that will ensure the goals are achieved.

In every department of the business, it is the employees who are at work, making sure that operations go on as they should. In the administrative and finance department, you have employees whose expertise are related to management and finance. In a production facility, the employees are the ones who ensure that the production processes are carried out smoothly. In sales, it is the employees that reach out to the market, engaging them so they will end up buying the company’s products or services. Furthermore, a company’s customer service is evaluated based on how the employees assigned interact with customers and take care of their after-sales needs and concerns.

Think of the business as a machine, and the employees the cogs that keep it running. Of course, there is a need to make sure that these cogs remain well-oiled, so the machine will continue running smoothly, and provide the expected and desired output.

Using that analogy, top management and business owners should also make sure that its employees are well-compensated.


Many people interchange employees “compensation” and “benefits”, thinking they are one and the same. In a way, they are similar, in the fact that they are received by the employees from the company that employs them. However, these are two different things.

Employee compensation is basically the payment to employees for doing their jobs. People are more familiar with the words “salary”, “wage” or “commission”. Even “tips” fall under employee compensation.

This covers items that are contained in formal or standard salary and/or wage programs or structures established by a company, an industry, or a regulatory agency that the company is answerable to. These programs and structures include salary schedules, and programs that are based on merits, bonuses and commissions.

Usually, an organization creates its own salary or wage structure, often in compliance with existing labor laws governing compensation. The ranges are usually identified with respect to the corresponding job descriptions; meaning, the higher the accountability and the bigger the responsibility, the higher the pay range.

Employee benefits, on the other hand, are those entitlements other than salaries, wages, commissions, and tips, and that can be given to employees in forms other than payment. These often come in the form of health or medical insurance, life insurance, disability insurance, employee stock options and profit-sharing plans, and even retirement plans. Vacation days, holiday pays and maternity and paternity leaves are also considered employee benefits.

Learn more about employee benefits in this interesting presentation.

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Compensation entails payment to the employees, which means it is tangible. Benefits can be intangible or tangible, so if an employee is transferred to a nicer office, allowed the use of a company car, considered for a promotion, or just given recognition by top management, he just got himself some benefits.

Another way to distinguish the two is that compensation is a right, while benefits are privileges. Compensation is required by the law, and that is not something that can be strictly said about benefits although, granted, there are some benefits that are mandatory, according to federal law. An example is unemployment insurance.

We can also say that benefits are given by companies to its employees in order to supplement their compensation, because they are given on top of the salaries and wages that the latter receive. The compensation is the cake, and the benefits are the icing on top.


Every country with a governing body is bound to have its own set of laws or legislation concerning employees’ and workers’ compensation.

These employment or labor laws encompass the rights and duties of both the employers and the employees or workers. This means that, even if the general perception is that the labor laws are in place for the primary protection of employees or workers, they are also established in order to protect the employers.

In the United States, the main player when it comes to the implementation of labor laws is the Department of Labor (DOL). To date, there are over 180 federal laws regarding labor that are being implemented. Below are some of the main laws or pronouncements on labor that are currently being enforced.

  • Fair Labor Standards Act (FLSA) prescribes the standards used by employers for wages and overtime pay and requires them to pay at least the federal minimum wage applicable to the state. It also underlines the prohibition of hiring children under the age of 18 for potentially dangerous jobs. Although children under 16 years of age are not banned from working, the number of hours they are allowed to work is limited, especially if they also happen to still be going to school.
  • Workers compensation programs per state or industry. While it is true that the DOL is the overseeing agency for matters related to employees’ compensation, the states are not precluded from coming up with their own state workers’ compensation programs. These programs often differ from state to state, and will also depend on the industry that the business belongs to. For example, employees in the maritime industry are governed by the Longshore and Harbor Workers’ Compensation Act.


We can classify these factors into two: external and internal.

The internal factors are those that emanate from within the organization or business. They include:

  • Management philosophy. It is a fact that some companies are more generous than others. This is why you cannot blame the top talents for “shopping” when they are applying for jobs in multiple companies. Naturally, they would go for the company that offers the higher compensation, and gives more benefits to its employees.
  • Fiscal capability of the company. As much as the top brass in the company would want to pay a lot to its employees, they have to consider the company’s ability to pay. The company may not be earning much profits to sustain the payment of generous compensation and benefits.
  • Union presence and influence. In larger companies, there are employee unions that hold a lot of power and influence. They are able to negotiate with management regarding employee remuneration.

There are also factors or forces outside the company that will affect how companies set up their compensation plans or pay structures.

  • State of the economy. Many times in history, economic downturns have dictated the labor landscape. In worst-case scenarios, millions of jobs have been eliminated and employees laid off. For those who were able to stay with their companies, they had to accept a decrease in their compensation. If the economy is healthy, this means that businesses are also on solid footing, so they will be able to pay their employees on a regular basis.
  • Competition. Companies that want to keep their employees with them will be hard-pressed to make sure they give generous compensation and benefits, especially when their rival companies or the competition is known to offer just as much, if not more, to its employees. It is a fact that competitors not only compete over sales and deals; they also take any opportunity they can to sway some of the most brilliant minds of the competition to their side of the fence. Also, there is that need among businesses to maintain a good reputation to the public, who is more inclined to give its support (and money) to companies who are known to take care of their employees very well.


Ultimately, employee compensation is one of the several ways that management can ensure the survival and longevity of a company. A business will continue to exist, earn profits, and even expand, if it has employees that are willing to put in all the work required. And how do you ensure that they perform? To give them the compensation due them.

But if we are to break things down further, we can identify several uses for compensation.

Compensation is a tool used to attract, recruit and retain employees. A company will be able to attract more talent, specifically the talent or skill set that they want, if they have a solid and attractive compensation plan in place. Job applicants will naturally seek to be employed in companies that have good compensation plans. Providing fair to generous compensation is also a way to ensure that your existing employees do not leave your business and seek employment elsewhere.

As a result, employee turnover is reduced, and loyalty of employees to the company is bolstered. We are also aware that quick turnover of employees means the company would have to incur costs on hiring and training new employees. In the long run, if you manage to keep your employees loyal to you through a well-developed and implemented compensation plan, you will be saving on these costs.

Compensation boosts employee performance and productivity. A well-compensated employee is a more productive employee. And we are not just talking about the output here, but also the personal and professional development of the employee, both as an individual and a member of the workforce.

By providing compensation, you are boosting their morale and satisfaction, so they have better attitudes when it comes to work.

In the same vein, compensation also facilitates movement within the organizational structure. More employees will be motivated to turn in their best performance, in the hopes of going up the ranks. Thus, the organizational dynamics will be more synergistic.


Companies have the freedom to design their own employee compensation system, provided they also comply with existing legislation and regulations.

When designing a compensation system, there are components that must be included, in order to ensure that employees get fair compensation.

  • Job description. The job description will establish the various aspects of the job, such as the duties and responsibilities it entails, the functions that must be performed, the location and environment where the job will be performed, and what are expected of the person that the job is assigned to.
  • Job analysis and evaluation. Through interviews, surveys and questionnaires, the job descriptions are analyzed in depth, to spot any redundancies. There is also a need to evaluate the jobs in order to determine the appropriate amounts of compensation, or compensation ranges that will apply to them.
  • Salary surveys. Market data on salaries and compensation will also be taken into consideration. Industry or market information, such as inflation rates and other statistical indicators, will come into play when determining compensation levels. This is also one way of remaining competitive, as competition among businesses also extend to the obtaining of talent or skill sets.
  • Company policies and regulations. Always, always, take existing legislation into account, but you must also consider the policies within the company. This is so you can avoid possible contradictions or conflicts of interest later on.


Let us now take a look at the two basic components that make up employees’ compensation.

A. Guaranteed pay

This refers to the fixed monetary reward paid to an employee. Often, it is also known as the base pay or base salary. This cash reward is determined and paid on an hourly, daily, weekly or monthly basis. Other companies even do it on a bi-monthly basis, depending on the existing company policies.

It is a fixed amount, which means that the same amount of base salary will be paid by the employer to the employee every end of the pay period, unless the employee is promoted, or there has been a raise in the fixed rate due to a change in policy.

In many countries and states, there is a defined minimum wage. Companies comply by adopting this minimum wage in its job pay program or plan, which is structured according to the job descriptions. Usually, the employee on the lowest rung of the ladder or hierarchy will have the minimum wage as his base salary, with the base salary increasing as we go up the organizational hierarchy, mostly based on skills, experience, and nature or description of the job.

In many cases, allowance also forms part of the guaranteed pay, the most common example of which is the cost-of-living allowance (COLA). This is often given to employees who have to be uprooted from their place or country of residence to work in another place.

And, as the name implies, this pay is guaranteed, meaning the employee will receive this amount while he or she is in the payroll.

B. Variable pay

Compared to the guaranteed pay, the variable pay is not fixed and not guaranteed. It is also paid in cash, but it is contingent on certain conditions, such as the discretion of top management, the performance of the employee, or the results or output achieved through the employee’s efforts.

One of the classic examples of a variable pay is commissions or sales incentives. In this type of payment system, an employee will receive a percentage of the amount he has sold. For example, a car salesman will get a certain percentage of every car he managed to sell. Real estate agents also get 50% of the gross amount of money they manage to bring into their agency from closing a real estate deal.

Overtime pay is another example of a variable pay, since it will depend on the number of hours worked overtime. Bonuses also fall under this category. For instance, a company may decide to give bonuses to the members of its sales team if they manage to surpass a specific amount of sales for the period.

The laws on employees’ compensation (and benefits) generally differ from state to state, since they are mostly governed by state laws. Granted, they are all generally the same in concept, but it is in the small details that you can spot differences.

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