Introduction to Compensation and Benefit Design: Applying Finance and Accounting Principles to Global Human Resource Management Systems
Appendix: The Terms
This appendix describes compensation and benefit terms in more detail than described in the main body of this chapter:
- Base, basic, fixed, “come to work” pay: The “fixed” part of pay. This element is provided to employees to come to work and do the job by using the required skills, knowledge, abilities, and appropriate work behaviors. Usually, this component is based on market rates combined with some measure of the internal ranking for the job or position, normally through a job-evaluation system.
Base pay can also be identified in many other ways:
- Wage: A fixed regular payment typically paid on a daily or weekly basis by an employer to an employee classified as a manual or unskilled worker. In economics, wage is the part of total production that is the return to labor as earned income as compared to dividends received by owners. Some contend that wages are paid to daily workers who are not necessarily employees. The implication is that the word wage is used to define the money a worker receives in exchange for labor (that is, physical labor). There seems to be a connotation that wages are given in exchange for physical labor and not brain power (physical strength in contrast to intelligence).
- Salary: A fixed regular payment typically paid on a monthly or biweekly basis but often stated as an annual sum. This is payment made by an employer to an employee as opposed to a worker. In other words, it is a payment made to a professional or a white-collar worker. A salary is a form of periodic payment from an employer to an employee, as stated in a recruitment contract. The payment differs from wages. In wage payments, each job or hour is paid separately. The distinction between salary and wages flows from the fact that for salaried employment the effort and output of “office work” is hard to measure in hourly terms.
- Compensation: The money received by an employee from an employer as a salary or wage. Therefore, the word compensation is used as an encompassing word covering both wages and salaries. But the pure definition of this word is money awarded to a person to compensate that person for his or her time, effort, abilities, knowledge, experience, and skills provided to an employer. This is the basis for an exchange; employer pays compensation, the employee provides the employer various personal attributes. When the exchange is not fair from the point of view of either party, there is dissatisfaction. Effective compensation is based on various motivational theories. A discussion about the theories is beyond the scope of this book.
Pay: Pay means the giving of money to someone that is due to him or her for work done. In other words, it explains the giving of a sum of money in exchange for work done. It also alludes to giving what is due or deserved. The notion of payment arose from the sense of pacifying a creditor. I want to pay him for his work (reward him, reimburse her, compensate him, give payment to him or her, or remunerate him or her).
In the current context, this concept needs some thought. It is not just wages or salaries that are being provided. Organizations are paying their human resources; they are rewarding, they are remunerating. The concept here is that the word pay should include both the perspectives of the giver and receiver of pay. This is a psychological transaction as much as it is an economic transaction. Both the supply (what the organization wants to provide) and the demand side (what the employee, who is the creditor being pacified) of the equation need to be considered to make the transaction fair to both parties.
All too often, organizations (both private and public) look at only the supply side and ignore the demand side (what the employee wants), and therefore pay remains one of the most emotionally disturbing work conditions.
- Remuneration: One will receive adequate remuneration for the work one has done (that is, a payment, pay, salary, wages; earnings, fees, reward, compensation, reimbursement; formal emoluments). So, this word is also an all-encompassing word.
- Rewards: A payment given in recognition of service, effort, or accomplishment. Today, the concepts behind the terminology listed here continue to evolve as part of a system of reward that employers offer to employees. Salary (also now known as fixed pay) is coming to be seen as part of a total rewards system, which includes variable pay (such as bonuses, incentive pay, and commissions), benefits and perquisites (or perks), and other schemes employers use to link reward to an employee’s individual performance. Tying it into performance in a clear, understandable, and acceptable way remains a continuing challenge. Good in theory, but fraught with real-life issues.
- Incentives or bonuses: These payments are provided to employees for achieving time-bound goals and objectives. Words such as incentive targets, objectives ( bonus objectives ), measurements, and ratings are all contextual terms used in most organizations. In economics and sociology, an incentive is any factor (financial or nonfinancial) that enables or motivates a particular course of action. These payments or gifts are added to what is usual or expected. Incentives are often amounts of money added to wages on a seasonal basis, especially as a reward for good performance (for example, a Christmas bonus).
- Allowances: These items are not benefits but are additional cash payments for special circumstances. These types of allowances are widely used in various countries. They are sums of money paid regularly to a person, specifically to meet specified life needs or expenses. It is an amount of money that can be earned or received free of tax or tax neutralized; examples are housing, education, hardship, transportation, special area allowances, foreign service premiums, and tax protection or equalization payments.
- Adders to base: These payments are common in the United States. Overtime pay, callback pay, and on-call pay (also called beeper pay ) are common elements provided for work that is done beyond normal work hours or under special circumstances. Overtime is provided for work done over standard legal working hours. Callback pay is special pay provided to technical workers who are called back to work after normal hours because they are needed to address a specific or an urgent situation. On-call pay is similarly an additional amount paid to employees who are required to be on-call by their employers to come into work when asked to do so. Beeper pay is provided to employees who have to keep electronic beepers on all the time so employers can access the workers on short notice.
- Risk benefits: Medical, disability, and life insurance. These benefits are provided to employees in lieu of cash to mitigate the various life risks faced by employees and their families. Employee benefits are regarded as nonwage compensation provided to employees in addition to their normal wages. Benefits can be regarded as transactions where the employee exchanges (cash) wages for some other form of economic benefit. This is generally referred to as a salary-sacrifice arrangement. In most countries, employee benefits are taxable at least to some degree. Some of these benefits are group insurance (health, dental, life, and so on), medical payment plans, disability income protection, daycare, tuition reimbursement, sick leave, vacation (paid and nonpaid), and Social Security. The purpose of the benefits is to increase the economic security of employees and protect them from unfavorable life situations.
- Retirement plans: Employers provide these benefits to assist employees with their post-employment lives. Usually there are two categories of retirement plans: the defined benefit plans and the defined contribution plans. Defined benefits plans are formula based, and defined contribution plans are contribution based. The contributions are made by participating employees. The fundamental objective of these plans is to provide an income-replacement payment. With this payment, participating employees should be able to replace a certain portion of their preretirement income during their retirement years.
- Equity compensation: This element in the past was mostly provided to senior executives to motivate them to increase shareholder value. But the equity compensation component of pay has seen many changes over the past ten years or so. There are many versions of these plans: nonqualified stock options, incentive stock options, restricted stock options, stock appreciation rights, among others. There are many accounting, tax, and legal implications to these plans. Some of the issues being discussed within this context are ownership culture, stock option pricing, dilution, and overhang. The equity compensation element has spawned specialists, legal experts, associations, and interest groups (each with their unique opinions and viewpoints). The important issues in equity compensation are (1) whether these programs have any value if distributed all across the whole employee population, even to the lowest employee levels, and (2) whether the organizations that distribute stock options widely to all levels of employees achieve an “ownership culture.”
- Perquisites: Many companies provide executives a wide variety of perks. This practice is widespread around the world. The term perks is often used colloquially to refer to payments because of their discretionary nature. Often, perks are given to employees who are outstanding performers and those who have seniority. Common perks include company cars, hotel stays, free refreshments, leisure activities during work time (golf and so on), stationery, and lunch allowances.