Note on Concept, Types, Determinants and Method of Compensation Management

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Compensation Management

Compensation management refers to all forms of financial rewards received by employees.Employees of an organisation use their overall efforts that need to be valued financially. Such financial values of contributions of employees to the organization are called compensation. It covers up important part of employee's life. It is generated from employment. 

 Compensation may be used for:

  • The recruitment and retention of qualified employee 
  • Help to increase the satisfaction of employees 
  • It helps to reduce absenteeism and turnover 
  • Helps in the increment of moral satisfaction 

According to Michael Armstrong," Compensation management is essentially about designing, implementing and maintaining pay system which helps to improve organizational performance."

According to Milkovich," Compensation refers to all forms of financial return, tangible services and benefits employee receive as part of an employment relationship."

Types of compensation


A) Direct compensation:

Direct forms of compensation have a multitude of types or methods, from salaries to bonuses.

Pay: Pay refers to the wages or salary received by the employee. It can be base pay or merit pay. Base pay is hourly, weekly or monthly pay and merit pay is performance based pay. It is an addition to the base pay. 

Incentive pay: Higher performance based reward is an incentive compensation. They can give piece wages, commission, bonus, profit sharing, the stock option. Rewards are utilized to build execution from the representative. This is a variable kind of compensation and is  found with salaried staff to incentivize them for a specific objective whether time or volume based


B) Indirect compensation:

Indirect compensation can be defined as the non -monetary remuneration which are provided to the employees such as:


Benefits: Benefits is an addition to pay. They are membership base financial rewards. They can pay for time not work, retirement benefits and executive benefits. Pay for time not work is like paid vacation, holidays, leaves, lunch breaks, bereavement. Retirement benefits are like pension, gratuity, insurance payments, provident fund, medical care etc. and executively is like a free newspaper, telephone rental, rent, vehicle etc.

Services: Services are not cash payment but considered as financial reward. It increases employee well-being. It comprises reward like housing, fooding, furnishing, child care and children education expenses, company car, aeroplane, discount on a purchase, credit card, loans, free legal advice and counseling for financial management and stock option scheme.

Most organization give compensation as a package. It consists of pay plus benefits and services. Compensation management must be flexible enough to get popularity in this human resource management function area.

Determinants of compensation

There are number of internal and external factors that affect compensation  which are:

Internal factors

Objectives of compensation

Objectives of compensation may be controlling cost, establishing fair and equitable pay structure, attracting and retaining competent human resources, improving motivation and morale, improving labour relation, improving the image of an organization and comply with the legal framework and policies of the organization.

Policies of an organization

Policies of an organization influence compensation. Compensation policy is the policy made by the organization.They serve as guidelines for formulating compensation. Organization can be leader or follower regarding pay.

Job evaluation

Job evaluation states job description and job satisfaction. These two factors determine the compensation to be required for payment. By evaluating a particular job, worth of job was determined. It determines the relative worth of a job in an organization. Job evaluation sets up a predictable and precise relationship among base pay rates for all employments.

Employee productivity

The new trend is to link pay with performance. Productivity determines compensation. Employees abilities and motivation affect productivity.

External factors

Legal consideration

Government law and regulation affect compensation management and policies. Government influences pay directly through laws, regulation. Tax implication also influences employees. Legal considerations can be taken as an important determinant of compensation. The government makes various rules and regulations to protect the interests of workers.

Market rates

Nature of demand and supply of various types of personnel determine compensation (wages and salaries). Market wage rates are to be followed. Wage rates will be different in a stable economy than in a depressed economy. Matching for the market rate is a major consideration. It should account for inflationary pressures. Skills in short supply carry the high rate of compensation. Compensation rates should be competitive.

Equity consideration

Equity means fairness in the relation between what a person does (input) and what the person receives (output). Determination of compensation is reasonably viewed in terms of equity. It should be fair within the same organization of similar jobs. Employees should view it as equitable and valuable. There should be equality between the employees otherwise, they will be demotivated. The rate of compensation should not be determined differently on the basis of religion, gender, caste, race etc.

The cost of living

Aggregate pay can influence purchasing power. Compensation should be adjusted according to the rise of market price rate. The cost of living at the average level may change. It is to be considered to maintain living cost through compensation. Organization should compensate the employee at least to meet the cost of living.

Union pressure

Union is a power and it affects compensation. Union pressure depends on the high rate of compensation through collective bargaining, negotiated pay settlements serve as the basis for compensation. Employees have the legal right to have collective bargaining. They work for all the members of the interest of their class.Generally, compensation is determined to balance the pressure of union and organization abilities.

Methods of establishing employee's compensation

Each job is to be valued in the organization. Compensation management determines the price of the job. There are various methods that can be adopted to establish employee's compensation. Employees compensation can be established by various methods:

Job analysis

Job analysis is a process of knowing dimensions of the job. Job analysis is the process of collecting and recording information related to the job to be done by personnel in order to design job and make human resource plan. Job analysis requires various information about the job. It comprises all the activities involved in the jobs like responsibility, accountability, job title, duty, authority and job relationship. It includes job description, job specification and job performance standard. The job description is the job requirement, job specification is person's requirement who needs different qualities to do a job and job performance standard is the target of the job to be done. It is a profile of a job that's why it is an overall summary of job requirements. They provide the basis for establishing compensation.

Job evaluation system

Job evaluation provides the value of job performance and accordingly, compensation is made. It ranks job in a hierarchy. It determines the relative worth of one job in relation to another job within the organization. It rates job. Job evaluation methods are the job ranking method, job grading method, factor comparison method and point system method. Job ranking method ranks job in order of their difficulty from simplest to the most complex. It appraises and worth the job highest to the lowest. Each job is to be compared with others to determine the overall rank. Job grading method is the group of different jobs requiring similar skills, efforts and responsibilities. Each job is assigned a grade. Factor comparison is a job content different factors like responsibilities, skill, mental effort, working condition etc. Each factor is valued in monetary terms. 

Compensation survey

This method of establishing compensation focuses on collecting information about compensation from the market. This provides external equity. Compensation survey provides the market rate of compensation. This can be done by published survey, consultants and agencies, advertisements and applications and informal communication. It is a market rate of compensation which can be determined by market rate. So, Compensation is determined on the basis of the information received from market or research by different experts and specialists.

Pricing jobs

This step prices job. Pricing job plays an important role in achieving the business goal. Pricing jobs involve grouping of different pay levels into grades. It shows pay ranges within each grade. It can be determined by ranking through the job evaluation process, legal factors, union pressures and the creation of pay grades etc.

Current trends in compensation

Compensation in present days to be studied is a need for achieving competent employees to bring effectiveness in day to day operation of the organization. It must be complete and at the satisfactory level of employees. Many studies have been taking place in recent few past years regarding compensation. Those current issues about compensation management are

Skill-based pay:

Compensation to employees is made on the basis of skills. Skill make the person competent to perform the job. The basis of the job is moving away from job base to competency based. Competency is a person's skills, knowledge, and behaviour that enable performance. Job-based pay considers the value of current job based on job title. Under this method skilled, semi-skilled and unskilled employees are grouped and compensation is made to them affording to their competency.

Broad banding

Reduced number of ranges of salary into a low number of the range is called broad banding. Generally, several grades are divided into three bands like clerical bands, professional bands and managerial bands. It provides flexibility for employee's assignment.

Comparable worth or pricing method:

Pricing job is an equity pay. The brand of compensating employees is to be on the basis of the value of job which gets the certain price. The main objective of developing this trend is to overthrow the inequity between male and female with respect to their compensation. It avoids races and class discrimination to their compensation. Under this method, the weight of each job is determined by considering its factors and certain value is given and on the basis of value, compensation is determined.

Cafeteria approach:

The important current trend in compensating employees is cafeteria approach that consists of pay plus benefits and services. The employee picks benefits and services as per needs within the limit of the pay package.

Variable pay plans

Variable pay plans is also current issue in compensation management. The use of variable pay system is increasing. This system is based on improving production and sharing of prosperity.


Lepak, D., & Gowan, M. (2010). Human resource management: Training and Development. Upper Saddle River, NJ: Pearson Prentice Hall

Kharal, S.k. (2006). Foundation of Human Resource Management. Asian.

Acharya, B. s. (2014). Foundation of Human Resource Management. Kathmandu: Asmita.

Adhikari, D. (2010). Human resource Management. kathmandu: Buddha.


  • Compensation management refers to all forms of financial reward received by employees.Employees of an organization use their overall efforts that need to be valued financially.
  • Compensation dissatisfaction causes absenteeism, turnover, job dissatisfaction, low performance, strike, grievances etc.
  • Job analysis is a process of knowing dimensions of job. It includes job description, job specification, and job performance standard.
  • Job evaluation methods are job ranking method, job grading method, factor comparison method and point system method.
  • Compensation survey provides market rate of compensation.
  • Pricing jobs involve grouping of different pay levels into grades. It shows pay ranges within each grade.
  • Compensation to employees is made on the basis of skills.
  • The important current trend in compensating employees is cafeteria approach that consists of pay plus benefits and services.
  • Direct compensation: pay and incentive pay
  • Indirect compensation: service and benefits

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