8.6 Employee Compensation and Benefits

Types of Compensation or Pay

There are two basic types of compensation: direct and indirect. Direct pay is the wage or salary received by the employee; indirect pay consists of various employee benefits and services. Employees are usually paid directly on the basis of the amount of time they work, the amount they produce, the type of work performed, or some combination of skill, time, and output. An hourly rate of pay or a monthly salary is considered base pay, or an amount of pay received by the employee regardless of output level. In many jobs, such as sales and manufacturing, an employee can earn additional pay as a result of a commission or an incentive pay arrangement. The accelerated commission schedule for a salesperson shown below indicates that as sales increase the incentive becomes increasingly more attractive and rewarding; therefore, pay can function as a powerful motivator. In this example, a salesperson receives a base monthly salary of $1,000, then earns 3 percent on the first $50,000 of product sold, 4 percent on the next $30,000, and 5 percent on any sales beyond $80,000.

Two other incentive pay arrangements are bonuses and profit-sharing. Employees may be paid bonuses for reaching certain monthly or annual performance goals or achieving a specific cost-saving objective. In this instance, employees are rewarded based on achieving certain goals.

In a profit-sharing plan, employees may receive some portion of the firm’s profit. Employee profit shares are usually based on annual company financial performance and therefore are paid once a year. With either a bonus or a profit share, an important incentive pay consideration is whether the bonus or profit share is the same for all employees or whether it is differentiated by level in the organization, base pay, or some other criterion. For example, a local company that specializes in building starter homes has 50 employees and pays an annual incentive share that is the same for everyone; the president receives the same profit share or bonus as the lowest-paid employee. In larger corporations, profit sharing can be restricted to certain levels in the company such as senior management and is often based on years of service and base salary. Southwest Airlines gives all employees, not just senior management, a share of the company's profits based on base salary and hours worked.

Indirect compensation includes pensions, health insurance, vacation time, employee perks, flexible work arrangements, and other related benefits. Other indirect compensation aspects are required by law, such as unemployment and worker's compensation, which are paid in part by employers. Unemployment compensation provides former employees with money for a certain period while they are unemployed. To be eligible, the employee must have worked a minimum number of weeks, be without a job through no fault of their own (i.e., they were not fired for performance issues), and be actively looking for another position. Some aspects vary by state, such as the number of weeks of work required to be eligible or recertification requirements. Some state laws permit payments to strikers. Worker’s compensation pays employees for lost work time caused by work-related injuries and may also cover rehabilitation after a serious injury. Social Security is a government program that provides financial support to retired and disabled individuals. This program provides a guaranteed income stream that is passed on to surviving family members when the individual passes. Social Security is funded in part through required payroll deductions similar to how taxes are deducted from employee pay. Medicare (health care for older adults) and Medicaid (health care for people whose incomes are below an established level) are separate government programs with enrollment and other portions managed by the Social Security Administration.

Many employers also offer benefits not required by law. Among these are paid time off (vacations, holidays, sick days), health insurance (including dental and vision), supplemental benefits (disability, life, pet insurance, access to counseling services), 401K contributions, pensions and retirement savings accounts, and stock purchase options.

Some firms with numerous benefits allow employees to mix and match benefit items or select items based on individual needs. A younger employee with a family may desire to purchase medical, disability, and life insurance, whereas an older employee may want to put more benefit dollars into a retirement savings plan. Pay and benefits are obviously important elements of human resource management and are frequently studied as aspects of employee job satisfaction. Pay can be perceived as very satisfactory, or it can be a point of job dissatisfaction. Data indicate that direct compensation is a key element of job satisfaction across industries and job levels.¹¹ As economic conditions, societal changes, and workplace cultures have shifted, benefits have become increasingly important to employees.