The concept of compensation


According to Barneat (1995), compensation is “equal in the opposite sense the effect of the thing with other” or ” giving or make a profit in compensation for any damage caused”, both definition can be found at the main element, the idea of exchange or return.

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If move this idea to the organizational field appears, immediately, the relationship between person and organization, a resource sharing relationship in which the feeling is reciprocal, where both elements what are offering and what are getting in return. (Chiavenato, 2000). This relation is established when the people bring to the work in exchange for something that receive in return. It is here where appears the concept of compensation, which is far from playing a instrumental role, becomes a important factor that determined the existence of the organization (Fernandez, 2002).

The compensation is concerned when the gratification that employees are getting for the work, included all forms of payment or rewards that the employees receive (Dessler, 1996), and contributing to the satisfaction, in addition this help the organization to obtain, maintain and retain a productive workforce


In general, motivation as a process, it is an internal demand of the persons and this is the motivation of the behavior of the person who will aim to meet this need. The persons have feedback about the behavior as a result people maintenance that behavior. This flow is described by Reeve (1994) y Davis and Newstrom (1993),

The flow of the motivation is dinamic and individual, this have different elements for example physiological, cognitive and behavioral and these interact between theirs. Applying the model of Davis and Newstrom (1993) (see the graph No 1), the compensation is the award obtained by certain behaviors

Elements of compensation

According to Villanueva and Gonzales (2005), total compensation consists of three main elements:

Base remuneration

Refers to the basic salary or wages, also called fixed income. It could be defined as the regular payment or the pay a person receives for the services when has contract for a company, which provides a structures and system of equal pay to employess, depending of the position, long term performance, skills and the market (Villanueva and Gonzalez, 2005).

The base salary is the plataform of the total compensation and consider the legal aspects of the market


Correspond to the variable component of total compensation because they are tied directly to the performance or productivity, in others words, there is a direct relationship between the what the employees does (results) and incentives to get of the company (Flannery, Hofrichter y Platten, 1997).

The amount of the incentives depends of the results and it is not guaranteed. The incentives can be called: bonus, profit share, commissions and stock options, these depend of the perdormance over the long or short term, goals, results and reducing costs.


These are commonly understood as non-monetary component of total compensation, including: vacations, life and health insurance, agreements, retirement plan. These elements depend mainly on the type of organization and the type of position in the company.

Example: Rene Brieffies, accountant with Pfizer European Financial Shared Services (EFSS) (The Times, June 26, 2005). “A GENEROUS benefits package helped to seal the deal for Rene Brieffies when he decided to change jobs. The 44-year-old moved to Ireland from Holland 12 years ago. Having worked as an accountant for most of that time, he was aware of the potential value of benefits. “It is very important,” he said. “Without benefits, the whole picture changes.””. Access on 7 April 2010:

Wilson (2002) suggests a fourth component of total compensation: the formal systems of recognition. However in the present work, recognition programs are not considered as a component but as an organization incentive, in other words is a strategy of the variable pay, because these have the condition of the direct relationship between performance and reward.

Functions of the compensation

Fernandez (2002) identifies four functions of compensation:

Strategic Alignment

The compensations are an excellent way to keep together the goals and values of an organization with the motivation and performance of workers (Fernandez, 2002), because the compensation is a communication way between employees and the organization

If the compensation has a designed properly, this indicated that the company wants as a result the employees adjust the performance and the work, but if the work is rewarded.

The relationship between the organization?s goals, motivation and performance of individuals, linked by the compensations, it is the role of strategic alignment.

Internal Equity

Refers to pay as the impact of each work on the business results. This impact is pay by work evaluations techniques. The total compensation payment is the sum of the charge and payment by results, after this, it is not possible to do an equal salary to look the same positions, then of course the income will be different according to the best or worst result for each employee (Fernandez, 2002)

External competitiveness

The compensations should facilitate the recruitment and maintenance staff that the organization requires. As a result, the company need looking at the market and establish the level of pay, because if the company do not pay what the market offers comparative, the probability of not found good talents, rotation and inefficiency is very high. “Compensation always should be the result between the internal equity and external competitiveness” (Fernandez, 2002, p.7)

Performance Management

The design of compensation must guarantee the performance of people is directed to what the company expects, because the idea is to link performance with overall business strategy. It is essential to have performance indicators to replace subjective assessments and uninspiring effects on the motivation of individuals (Fernandez, 2002).


In many organizations have begun to restructure and transform the work culture and these have been forgotten, or have escaped of the “human resource challenge today: reformulate the wage strategies” (Fierman, 1994, en Flannery, Hofrichter y Platten, 1997, p.128)

It is very important to understand that culture and wage strategies are mutually supportive, therefore, these are should not be considered in a vacuum, but must be parts of the values, structures and changing organization goals (Flannery, Hofrichter y Platten, 1997).

Just as certain cultures are more suited to inspire and support certain types of organizations, certain remuneration strategies are more effective in supporting certain cultures. Thus, the harmonization of remuneration system with the culture is crucial if an organization aims to achieve the desired business results. (Flannery, Hofrichter y Platten, 1997).

In this context, Flannery, Hofrichter and Platten (1997) suggest the dynamic compensation, stating that compensation strategies must be dynamically aligned to the different types of work cultura prevailing in an organization, to guide employees towards the kind of work and performance desidered. One can argue that there will be many systems of labour compensation as there are cultures in an organization (Rodriguez, 2001, in Fernandez,2002).

In conclusion, the dynamic compensation refers to a remuneration to be constantly changing as the organization evolves. In other words, the success of a compensation strategy that improves the performance of their employees, have harmony and synchronicity that exists between values and culture present in the organization.


Wage strategies are concentrated on two key areas and crucial for organizational success: personnel and performance. However, although strategies such as pay based on ability and competence, these are often vital to the development of new values and behaviours needs to change the organization (Flannery, Hofrichter and Platten, 1997), the connection that links the individual and the performance with the result and ultimate success of the organization (Fernandez, 2002).

This link has existed for years, but only for a few groups of employees, usually senior executives and lower levels of the organization for example sales team. However, organization have begun to extend incentives programs, which have found that when employees to share risks and profits of the organization, as a result a better performance and their have more responsibility for that. (Flannery, Hofrichter y Platten, 1997).

The variable payment system based on performance is different to others traditional forms of compensation, this not pay for time or specialty, but with a individual or collective performance. In this way, the person do not have security about the amount in the next pay because this is no the same that the fixed income, the amount will depend only of the objectives and the results. The earning fluctuates according to the results of performance.

This system is attractive for the administration, because “part of the fixed costs of the remuneration are converted into variable costs, in consequence, the costs are reducing when performance declines” (Robbins, 2004, p.199). In the other hands, the linking payment with the performance have a consequence in those who do not have good result in theirs objectives, they find that the pay are stagnating. By contrast, the increase observed its outstanding employees with good remuneration by their contribution with good performance.

The key to the success of the strategies based in the performance, as other forms of payment is the synchronization. The variable compensation should be adapted to the work culture and values for the organization and employees. Thus, the strategies of pay based in performance can be powerful tool for motivation employees to the expected performance (Flannery, Hofrichter y Platten, 1997).

Other important point to the success of variable pay programs is to have the highly effective performance management and communication strategies to support them (Flannery, Hofrichter y Platten, 1997). In fact, if the organization want to link pay to performance, it is essential to have effective tools to evaluate it.

According to Flannery, Hofrichter and Platten, the variable compensation based on performance can be found a number of variable pay components. The following are used by organizations today:

Shared Benefits

It is sharing, a group of employees have a fund created by a percentage of benefits provided, usually through a formula. Although revenue sharing can be effective to focus employees on the financial performance of the organization, often it has difficulties in relating the performance of individual efforts. These programs can motivate employees in a general appearance, but this do not contribute directly to improved performance or change the behaviour of individuals or teams. However these are effective in organizations with fixed remuneration for low of the market or the same level and the organization need the flexibility to pay above the market in good times, without having to cut staff or costs in the difficult years. These incentives are most frequently used in groups under the managerial level.

Example: Lincolnshire-based group (The Times, March 6, 2005) “The Lincolnshire-based group, established in 1956, has its fingers in lots of pies, the biggest of which are land, construction and houses. Benefits include 10% of all profits being shared equally among staff, and turnover is low – 34 people have been at Lindum for more than 15 years, 162 have worked here for between five and 10 years.” Access on 7 April 2010:

Profit Sharing

This variable compensation program is related to the achievement of very specific goals of productivity, profitability and quality improvement. If these goals are achieved, then the group shares a fraction of the resulting monetary benefit. This is different than the shared benefits; this is not concentrated on a fixed percentage of the profits. The advantages of the plans for profit sharing that the shared benefits are double. Firstly, the employees are self-financed, their have money that the organization would not otherwise be saved or earned. And secondly, the connection between performance and result is much clearer. The plan need be well created and well communicated; the employees can see that changes in behaviour and values are needs for the expected results.

Incentives for small groups

Many organizations can not to expand the variable remuneration to all employees, these have begun to create incentive programs for specific groups, for example professional or project groups. Incentives for small groups are used usually for projects, these are temporary and until the group has finished it. In general, group members share equally the payment, although the pay may vary according to the specific level of contribution.

Individual incentives

Traditionally, these incentives have been reserved for senior executives, sales staff and in some cases employees who work for hours. In general, these are relatively simple and performance oriented, the employee receives a bonus if the sell have a certain amount of products or achieve financial goals.

Example: M&S, (The Times, June 5, 2009) “The annual report confirmed that none of the retailer’s directors will get a bonus for 2008-09 after M&S reported a 40 per cent fall in full year pre-tax profits. It also disclosed that none of its executive directors would receive a pay rise this year.” Access on 7 April 2010:

Example: Bank sector in United States (The time, December 18, 2005) “Total pay and benefits at the bank rose 21% to $11.7 billion in 2005. The rise means Goldman’s 22,000 employees now average $521,000 in pay, bonus and benefits, up 12% from $466,000 in 2004. Among big deals this year Goldman advised on Telefonica’s ?17.7 billion bid for 02 and Ford’s $15 billion sale of Hertz, the car-rental company. Staff at Goldman, Morgan Stanley and Lehman were all informed of their year-end bonuses last week. John Mack, chief executive and chairman of Morgan Stanley, will take a stock bonus of $11.5m for his first five months in the job plus an $800,000 base salary. Richard Fuld, Lehman Brothers’ chairman and chief executive, received a $14.9m stock bonus” Access on 7 April 2010:

Long term incentives

Traditionally used with the organization?s execute team and these were created to concentrate the goal on long term results. Nowadays, some companies are used this program at lower levels. The idea is to maintain high performance in the long term. While the most of the programs long term incentive is created around some form of equity participation program, there are other that used others financial powers. For example the software designers can receive royalties from sales of its software.

Total sum payments

It consists of periodic payments, usually annual, and these are used to reward those employees with high performance and high salary. When the organization paid in a separate payment, these can avoid the progressive increases of wages and benefits, with this limiting the increase in fixed costs. However, these payments often do not provide a real incentive. These reflect a trend toward a modest market position and less competitive.


There is a relation between work motivation and compensation, it is possible to recognize the existence of a trend that suggest that compensation, when both concept have a properly designed manage, these can to influence the motivation of employees to show better performance.

When the organization is implementing some compensation plan, it is necessary to consider a number of facors specific to each organization to ensure and achieve its objectives: attract, retain adn motivate employees. These factors relate to organizational structure, culture and values of the organization, communication, management style.

The compensation is directly related to all human resources processes, for which strategic coordination is essential. In particular, performance evaluation systems.

When implement a compensation system will be necessary to understand the culture of the country where the organization is working, this will cause a differential impact on the perceptions and priorities of employees, depending on the cultural aspects valued as rewards.

Nowadays, the organization must be flexible with respect to the changes in the experience. The dynamic compensation is used, and the compensation plans must be constantly updated and aligned with the values, policies and specific characteristics of each organization.

Do not forget that the compensation systems as well as the different human resource strategies are business communication tools that guide employees to think about the priorities of the organization clarity and consistency are a contribution to the work environment and the establishment of equitable cultures and perceived as fair by employees

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Davis K. And Newstrom J. (1993). “Human behaviour at work”. 8th Edition. Mc Graw-Hill.
Dessler G. (1996). “Personnel administration”. 6th Edition. Prentice-Hall Hispanoamerica.
Fernandez I. (2002). “Trends in management compensation in the Chilean market. XVIII Interamerican Congress of Psychology”. Access on 6 April 201:
Flannery T. Hofrichter D. And Platten P. (1997). “People, performance and payment: Dynamic compensation for the new business environment”. Paidos Editorial.
Reeve J. (1994). “Motivation and emotion” Mc Graw- Hill
Robbins S. (2004). “Organizational behaviour”. Pearson Editions
Villanueva A. and Gonzales E. (2005). “Management of compensation I” Chile
Wilson t. (2002). “Effective remuneration systems”. 5th Edition. p. 1-6. Chile

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