Compensation Essay

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Concept of Compensation

Compensation is one way of managing to improve job performance, motivate and improve employee performance. Compensation is important for employees as individuals because the amount of compensation between the employees themselves, their families, and society reflects the size of their work. Compensation is also often referred to as an incentive and can be defined as any form of reward given to employees as a reward for their contribution to the organization.

Employee compensation according to Dessler (2006) has two (two) main components:

  1. direct payments; (salaries, wages, promotions, commissions, and, bonuses),
  2. indirect payments; (financial benefits such as workers ' insurance and vacation).

According to Ivancevich (2007), the object of compensation is to create an acceptable system of incentives for workers and employers, the desired result is an employee who is committed to his job and driven to do a good job for the worker. The compensation given ought to reflect a job's value. Compensation or compensation for the benefit of the company and its staff in general.

Compensation according to Rivai (2009), where the outline of the compensation program can be divided into two (two) major groups, namely:

  1. form-based, divided into; (a) financial compensation; (b) non-financial (non-financial compensation) compensation;
  2. form-based, divided into; (a) direct compensation, i.e. (b) indirect compensation.

Based on the literature review and frame of thought, hence the concept of compensation can be formulated as follows:

  1. Compensation has a significant effect on work motivation.
  2. Compensation has a significant effect on job satisfaction.
  3. Work Motivation has a significant effect on job satisfaction.
  4. Compensation has a significant effect on employee performance.
  5. Work Motivation has a significant effect on employee performance.
  6. Job Satisfaction has a significant effect on employee performance.

· The Importance of Compensation on Employee Performance

Thierry (1987) stated that some 3 perceived features, which are transparency, fairness, and, controllability, depend on compensation systems to be effective. These perceptions have a connection that is discussed in more detail below.

a) Transparency

Depending on how transparent a compensation system is viewed, how it is communicated, and how complex it is. Not only does a transparent system inform employees who do not want to risk the rules of the compensation system, but it also brings them up to date with the organization's objectives. If effectively communicated to these staff, the rules will facilitate their understanding of the works of the system and create an environment to support the compensation system implementation. Uncertainty (Perceived) decreases incentive compensation effectiveness (Gibbons, 1998).

In short, how employees perceive a transparent compensation system will have a positive and propelling effect on their level of performance motivation. The risk of hard work and not getting compensated in return is projected to make employees want to put more effort into it and thus increase performance.

b) Fairness

According to Prendergast (1999), while the economic trust theory is not well developed, it is expected that the principal's reliability and trustworthiness will greatly influence the employee's actions. Other theories, such as the theory of reciprocity, also focused on the concept of fairness but used various angles. It mentions that the employee's compensation should be a fair amount in relation to the employer.

According to this theory, any surpluses created in the agency contract must be fairly divided in order to increase incentives. If the employee perceives that this concept of fairness has not been delivered anyway, there is a likelihood that their performance motivation will be reduced, thus reducing performance.

c) Controllability

The third feature we use to evaluate the effectiveness of the compensation system is the perceived relationship between effort and compensation (variable).

Baker (2002) defines the extent to which the employee is capable of controlling or influencing the result.

The Impact of Compensation on Employee Performance

A compensation package does not necessarily mean a monetary reward. Flexible benefits, medical care, work-life balance, and employee benefits are also included. Employees of today not only work for the money but also put equal emphasis on other compensation aspects.

Now we are going to focus on those factors that have a direct impact on employee’s performance because of compensation, which we have found by going through some research papers & journals.

1. Retention

One of the most effective ways in which compensation can have a positive impact on employee retention is to build an employee development plan that promises the company to track career opportunities for employees. Being on an upward career path should be accompanied by an increase in salary and merit. Moreover, performance-based bonuses motivate employees to align their individual goals with corporate goals. Implementing incentives such as stock options, profit sharing, and, spot rewards are other ways in which retention is affected by compensation. These forms of compensation show how critical the performance of employees is to the overall profitability of the organization. Spot rewards are usually not as lucrative; however, they provide immediate recognition, reward, and, compensation when an employee performing superior work is observed by company leadership. Appreciation is key to the retention of employees and if compensation is part of the recognition, it is likely that compensation will increase the retention of employees.

2. Fairness

Fairness in compensation is when employees feel that their pay reflects the quality of their work accurately. The perception of a fair compensation package is likely to depend on a number of factors including the skills and responsibilities required for the job, the time and effort put in, and how the pay and benefits compare with what others are receiving for similar work.

Importantly, fair compensation does not necessarily mean equal pay for employees, but it requires that any differences in compensation reflect real differences in the skills, responsibilities, and/or effort of employees at work.

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3. Pay Equity

Pay equity is thought to be a very powerful motivator (or de-motivator, depending on the situation) — the feeling that one's pay is on par with those around them. Research shows that people will be less motivated to take on a new job if they think higher pay packages for similar positions have been offered to other people. Similarly, research presented in the WorldatWork Journal Found that 25 percent of employees say fair pay is an organization's most important thing they want.

Employers must then pay employees at the right level, and they must show employees that pay is fairly allocated within the organization.

4. Motivation

Compensation is the primary motivating factor for employees to push for higher heights on an ongoing basis. It provides them with a reason to work hard and continue to drive towards the next milestone.

On the other hand, in the absence of a good compensation package, employee performance and efficiency can be drastically affected.

5. Job Satisfaction

According to the report from the Society for Human Resource Management, compensation is the top contributor to job satisfaction. In fact, 96% of the employees surveyed say that compensation is important or very important to their overall job happiness.

Employers should engage their workforce on a regular basis with surveys and feedback sessions in order to determine where everyone is satisfied. Low employee happiness rates can result in lower productivity, absenteeism, and attrition. If wages can not be raised, employers need to look for other ways to compensate employees for their work. These efforts can be enhanced by non-monetary rewards such as group outings and flexible hours.

6. Productivity

In some organizations, the effect of compensation on the productivity of employees could be very strong. It is stated that good employee compensation can stimulate the emergence of fresh ideas and the innovation of employees. It would be very useful for the company with so many ideas from employees.

A similar study has found that the existence of good employee compensation will also improve employee health. The employee will gain maximum performance opportunities with health maintenance. Maximum work performance can be achieved by the number of working hours or employee present hours. As a result, the planning process can be obtained with good production. They also noted that low employee compensation will trigger the employee to try to get their own business or side work. It will disrupt the quality of the work and concentration of employees with the side business. Low concentrations of some employees have a negative impact on the company's goods manufacturing quality and quality. It is clear from these facts that the influence of compensation on the productivity of employees is very strong. If it provides employees with more reasonable compensation, the higher the employees ' productivity.

By contrast, if the employee receives lower compensation, the lower the employee's productivity.

7. Turnover

People would like to be well compensated. They must cover standard expenses such as housing, food, and utilities. And most people also want sufficient money for extras. If you don't pay your staff well, they're going to find a business that's going to.

It is good to do wage market research when determining compensation for your employees. Find out what your competitors are paying for their staff. Based on similar jobs in your local area, research a competitive salary range.

And you can't just give and do paychecks to employees. Employees also want good advantages. You have to offer the competitive advantages your employees want. Learn about the benefits common to employees. Then find out what benefits your area offers to competitors and other businesses.

8. Alignment Problem

The alignment of performance management and compensation systems is based on accurate job descriptions, clear communication of expectations with employees, a fair and competitive base compensation plan, and the philosophy of performance-related compensation of your institution. Always keep in your line of sight the intent and purpose of your systems, and it will help you stay the course and effectively manage performance and compensation.

9. Agency Problem

If the organization follows the mechanism to minimize agency problems like,

  • performance bonus
  • cash bonus
  • granting the stock option
  • insurance policy etc

Then there will be fewer agency problems, employees will be satisfied and performance will increase.

10. Organizational Citizenship Behavior

In order to ensure OCB, pay structures preferred to be established on the basis of individual contributions, it is also necessary to introduce the salary required to match that of external associated organizations as well as allowances related to competence. Employees who are happy with rewards are passionate about working and are more committed to the organization.


After going through different research papers & journals on how compensation affects employee performance, we have found these factors.

An effective performance management system that is absent in many organizations goes a long way to ensuring equity n in the distribution of compensation packages and in the actual evaluation of the entire compensation system in order to be up-to-date with the situation on the job floor and thus achieve the desired result.

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Compensation Essay. (2022, September 27). Edubirdie. Retrieved April 18, 2024, from
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