# Compensation and benefits

Compensation and benefits refer to remuneration to employees from employers. Which is the payments or rewards provided to an individual for the work that has been completed.
Compensation is the direct monetary payment received for work performed, commonly known as wages. This is the compensation that employees earn for their work or contributions to the organization. This term may also denote a structured method in which employees receive financial compensation and additional benefits in return for their labor and contributions. Compensation can be any form of monetary such as salary, hourly wages, overtime pay, sign-on bonus, merit bonus, retention bonus, commissions, incentive pay or performance-based compensation, restricted stock units (RSUs) etc
Benefits are any type of reward offered by an organization that is classified as non-monetary (not wages or salaries). These rewards are typically funded fully or partially by the employer. Employee benefits refer to the extra advantages offered to employees in addition to their salary. These consist of packages provided by the employer to enhance the cash compensation. Benefits typically encompass health coverage, income protection, savings, and retirement programs, all of which offer security for employees and their families. Benefits, often referred to as indirect compensation, are provided to employees through various plans instead of cash payments. These are including health insurance, retirement or pension plans retirement benefits, vacation time, sick time or other paid time off, flexible work arrangements including remote, hybrid or windowed work, healthcare savings account (HSA), flexible spending account (FSA) for healthcare or dependent care costs, transit benefit account, training or continued education subsidies, childcare subsidies, work from home equipment reimbursement, employee recognition programs, meal reimbursement etc.

## Basic components

Compensation and benefits can be primarily categorized into two types: monetary (direct compensation) and non-monetary (indirect compensation). The key components are outlined below:

### Monetary

* Base Salary or Guaranteed Pay – a fixed monetary reward paid by an employer to an employee. This refers to the regular amount of money that an employee receives consistently. The basic salary, often referred to as the base or fixed salary, is the set amount that an employee receives for their standard work. This figure does not include extra compensation such as bonuses or benefits. The total compensation package includes a crucial component that is usually represented as an annual, monthly, or hourly rate. The basic salary is influenced by several factors, including industry standards, the individual's experience, job responsibilities, and legal regulations such as minimum wage laws. This also forms the foundation for determining additional payments such as overtime, bonuses, and deductions for taxes or social security. While it constitutes the main component of pay, additional benefits and incentives contribute to an employee's total compensation package.
* The Variable pay – a non-fixed monetary reward paid by an employer to an employee. Variable pay is a flexible and performance-based part of total compensation that can greatly influence employee motivation and contribute to the success of the organization. It is a compensation system where part of an employee's earnings is tied to their individual performance, team success, or the organization's overall outcomes, unlike fixed salary, which is guaranteed. This approach motivates employees to meet specific goals or performance standards, and the criteria for earning variable pay vary by company and industry. Common forms of variable pay include performance bonuses, sales commissions, profit sharing, stock options, and incentive programs. It aims to align employee actions with organizational goals, enhance performance, and attract or retain talent by offering the chance for additional earnings based on results.

### Non-monetary

* Benefits – Employee benefits refer to the non-wage advantages offered by employers alongside standard salaries or wages. The benefits included in this total compensation package are designed to attract, retain, and motivate employees, while also improving their well-being and job satisfaction. Health insurance can cover medical expenses and promote overall health. Dental and vision insurance is available for routine care and corrective needs. Additionally, mental health support helps employees manage stress and emotional challenges. Retirement plans such as 401(k)s and pensions assist employees in saving for their future, while stock options connect their interests with the success of the company. Opportunities for professional development, including training programs and educational assistance, facilitate career advancement. Benefits related to work-life balance, such as paid time off, flexible work arrangements, and parental leave, assist employees in addressing personal and family responsibilities while enhancing job satisfaction.
* Equity-based compensation – also known as share-based compensation, refers to a type of non-cash payment in which employees are granted ownership stakes in the company. Examples are stock options, restricted stock, stock appreciation rights (SARs), and employee stock purchase plans (ESPPs). Equity compensation offers a significant advantage for companies by enabling them to reward employees without affecting their cash flow directly. In turn, employees have the opportunity to receive financial benefits through ownership. This compensation may be provided right away or may require a vesting period, which means employees must remain with the company for a specified duration before obtaining full ownership. Startups usually designate 10-20% of the company's equity for employees, while the founders and investors retain the remaining shares.

## Guaranteed pay

Guaranteed pay is a fixed monetary (cash) reward.
The basic element of guaranteed pay is base salary which is paid on an hourly, daily, weekly, bi-weekly, semi-monthly or monthly rate. Base salary is provided for doing the job the employee is hired to do. The size of the salary is determined mainly by 1) the prevailing market salary level paid by other employers for that job, and 2) the performance of the person in the job. Many countries, provinces, states or cities dictate a minimum wage. Employees' individual skills and level of experience leave room for differentiating income levels within a job-based pay structure.
In addition to base salary, allowances may be paid to an employee for specific purposes other than performing the job. These can include allowances for transportation, housing, meals, cost of living, seniority, or as payments in lieu of medical or pension benefits. The use of allowances varies widely by country, as well as job level and the nature of job duties.

## Variable pay

According to Bussin (2019), the most prevalent types of variable rewards are generally categorized as short-term incentives (STIs) and long-term incentives (LTIs). While definitions may vary, these can typically be understood as follows:
Short-term Incentives (STIs):
Short-term incentives (STIs) are designed to reward exceptional performance achieved within a one-year period, focusing on past accomplishments. This retrospective approach ensures that employees are compensated based on measurable outcomes from the previous year. Common examples include profit sharing, gainsharing, bonuses schemes, and commission schemes.
- Profit sharing: Profit-sharing is a compensation strategy in which employers distribute a portion of the company's profits to employees, typically as an addition to their regular wages or salaries. The goal is to motivate employees by aligning their financial interests with the company's overall performance. Effective profit-sharing plans require careful design, considering factors such as company size, employee participation, and a clear profit-sharing formula. If well-executed, profit-sharing can enhance employee motivation, productivity, and overall organization performance, particularly in environments that emphasize teamwork and collaboration.
- Gainsharing: Gainsharing is a highly effective incentive system that encourages employees to work collaboratively by rewarding performance improvements. By focusing on participation and teamwork, gainsharing motivates individuals to contribute beyond their standard responsibilities, resulting in enhanced problem-solving, cost reduction, timely delivery, and higher-quality outcomes. This collective effort ultimately benefits the organization's bottom line, making gainsharing a valuable approach for achieving better results.
- Bonus schemes: In the context of corporate finance and compensation, a bonus is a form of additional compensation awarded to employees, typically based on performance metrics or achieving specific goals. Bonuses can be monetary or non-monetary and are often used to incentivize employees to meet or exceed their performance targets.
- Commission Schemes: Commissions are a type of incentive that can typically expressed as a percentage of sales revenue, gross profit, or a fixed amount per unit sold. In a full commission or straight commission plan, employees earn their income solely through commission. This model is commonly used in sales-driven environments to incentivize high performance by directly tying compensation to revenue generation.
Long-term Incentives (LTIs):
The design of long-term incentives (LTIs) is to reward exceptional performance over periods that extend beyond a single year. Unlike STIs, which focus on past achievements, LTIs are forward-looking, encouraging sustained performance and aligning employees' goals with the long-term objectives of the organization. These schemes foster a culture of continuous improvement and commitment, helping drive ongoing growth and innovation. Examples of LTIs include share schemes.
- Share Schemes: Share schemes, such as stock options or Employee Stock Ownership Plans (ESOPs), offer employees a stake in the company by granting them shares. This aligns their interests with those of the shareholders, encouraging long-term commitment and fostering a sense of ownership. Employees benefit from the company's success, as the value of their shares increases with the company's profitability, creating a powerful incentive for both individual and organizational success (Investopedia, 2024).
Organizations should use a combination of short-term incentives (STIs) and long-term incentives (LTIs) in their compensation packages. This approach helps ensure the organization's long-term sustainability by discouraging executives from prioritizing short-term gains at the expense of the company's future. A well-designed total compensation plan should prevent executives from engaging in harmful short-term behaviors.
Why Implement Variable Pay?
According to Bussin (2019), more and more companies are adopting incentive and bonus schemes to boost employee performance and align individual goals with organizational objectives. These schemes offer several key benefits:
- Improved Performance: Incentivizing employees can drive superior individual, team, and organizational results.
- Shareholder Alignment: Variable pay can align employee interests with those of shareholders, fostering a sense of ownership.
- Cost Management: By tying part of compensation to performance, companies can better manage their overall salary costs.
- Recognition and Reward: Variable pay provides a tangible way to acknowledge and reward employees for their contributions.
- Strategic Alignment: Well-designed incentive schemes can help drive organizational strategy and achieve specific goals.
By implementing variable pay, companies can create a more motivated and engaged workforce, ultimately leading to increased profitability and shareholder value.
An example where this type of plan is prevalent is how the real estate industry compensates real estate agents. A common variable pay plan might be the sales person receives 50% of every dollar they bring in up to a level of revenue at which they then bump up to 85% for every dollar they bring in going forward. Typically, this type of plan is based on an annual period of time requiring a "resetting" each year back to the starting point of 50%. Sometimes this type of plan is administered so the sales person never resets or falls down to a lower level.
It also includes Performance Linked Incentive which is variable and may range from 130% to 0% as per performance of the individual as per his key result areas (KRA).

## Benefits

Benefits consist of the non-wage compensation that form the total remuneration package for an employee.
While there is less research in this field, it is an important field, as benefits can create significant costs for employers, be they through compulsory means (e.g. compulsory pension schemes), or by the discretion of the employer (e.g. childcare allowances). Benefits can also be seen as an attractor for potential employees and can reduce turnover.
Employers can offer a wide range of benefits, these generally fall within the categories of:
* Health and wellbeing - Employee Assistance Programmes (EAP), or a 'wellbeing allowance'.
* Special leave - Leave to attend to matters outside of work such as sporting commitments, volunteering, or meeting cultural commitments.
* Career development - Support of study in both payment of fees and paid time to study, and secondment or shadowing opportunities.
* Retail discounts - Discounts in a retail setting (e.g. Cost plus sales tax offers, for certain retailers).
* Financial product discounts - Discounts on services such as loan interest rates or insurance policies.
* Flexible work - Includes working from home (WFH), flexible start and finish times, and reduced hours of work (e.g. the 4 day week).
Reciprocity theory is an important theory underpinning benefits, as it builds a social norm whereby an employer provides a 'positive' benefit, which is warmly received. In return the employee is inclined to provide positive workplace behaviour, strong productivity, and strong organisational commitment which is the bond or attachment that an employee has towards their employer, and subsequent levels of involvement.
Social exchange theory is another relevant theory which suggests that employees weigh up the total benefits and costs of their relationship with the employer. If an employee feels the costs of their work or employment relationship outweighs the benefits received from their work, the employee will be more likely to choose to end the employment relationship, to pursue an employment relationship that provides greater regard for benefits and social exchange theory.
The motivation for an employer to provide benefits can vary. While the overall intent of benefits is to keep employees satisfied with their employment, employers may provide benefits to mitigate disruption caused by increased union density and increased bargaining power. In other instances, employers may provide benefits as a result of a union bargaining for strengthened benefits.
When an employer provides benefits, it is critical to note that benefit systems must adhere to the principles of organisational justice. Organisational justice is seen as 'the extent to which employees perceive workplace procedures, interactions and outcomes to be fair in nature'. The principles of organisational justice include:
* Procedural justice - How fair policies and procedures are perceived.
* Informational justice - How fair rationale for benefit policies, procedures, and outcomes are perceived.
* Interpersonal justice - How fair interactions are regarding benefits perceived.
* Distributive justice - How fair access to benefits are perceived.
If an employee perceives that the benefits system lacks organisational justice, the perceived or actual satisfaction with benefits is undermined.
The overall satisfaction with the system of benefit administration is called the benefit system satisfaction, while benefit level satisfaction refers to the satisfaction an employee has 'with the amount of benefits they receive'.
It is important to note that benefit satisfaction can be viewed as actuarial value benefit satisfaction and perceived level of benefits. it is interesting to note that some employees are more satisfied with the perceived value of benefits. This could include an employee having the potential benefit of flexible working, which may not be utilised. The employee will still note satisfaction with the potential benefit.
However, benefit system satisfaction, is based on the:
* Satisfaction of the administration.
* Determination of the benefit.
Benefit systems which are seen to be of value and managed well, will result in satisfied employees. These employees will feel that their employer is supportive of them, and their 'perceived organisational support' will increase. This is important as perceived social or organisational support can be one of the most significant factors in building resilient employees and reducing unplanned turnover.
Employees will also build a sense of emotional commitment towards their employment which will foster in them a willingness to perform highly.
While an employer may establish benefits, it is worth considering the importance of demographics on benefit satisfaction. For example, a workforce with a significant number of parents may value a benefit package which is centred around supporting them and their children. However, those without children, may perceive these benefits as unfair, irrelevant, and a financial disadvantage as they cannot gain the same financial benefits as employees with children.

## Vertical Pay Dispersion

Pay dispersion is defined as the 'differences in pay levels between individuals within (i.e., horizontal dispersion) and across (i.e., vertical dispersion) jobs or organisational levels. Vertical pay dispersion is specifically the difference in remuneration between the most senior employees of an organisation (e.g., Executive Directors of Chief Executive) and an average employee.
Vertical pay dispersion has recently become a topic of political, social and news media discussions. In particular, special attention is paid toward cases where the difference of an executive director of an organisation is seen to be disproportionately high, when compared to the rest of the workforce and the difference in pay is visible within the organisation. Whether an organisation is in the public sector or private sector, research shows people care about the difference between what they are paid and what those at the highest level are being paid – it is important to an employee.
There can be short-term and long-term effects of vertical pay dispersion. Research suggests some short-term effects of vertical pay dispersion can lead to increased outputs and productivity in employees. This is based on the idea that competition is a driver of human motivation, and prizes such as a change in status or remuneration in an organisation (e.g., promotion to a higher-paid position) or other extrinsic motivators can encourage employees to perform better within their role. Research on the long-term effects of higher vertical pay dispersion in an organisation are commonly negative, and usually are associated with dysfunctional behaviour in employees, increased employee turnover, short-sightedness, reduced teamwork and lower intrinsic motivation.
There are academic theories which help to explain why vertical pay dispersion exists within an organisation, and how it can have both positive and negative effects.

### Tournament theory

Tournament theory is based on the idea of "tournaments" or "competitions" in an organisation, where there are clear winners and losers. Tournament theory states individuals are best motivated to perform well when any prizes available to be won are based on winning or failing, rather than just a monetary value. Employees within an organisation will compete against one another to win higher-level positions, which are usually associated with higher pay.
The theory is based in economics, which assumes an individual is a rational economic actor who will aim to maximise their individual utility, with the prize as the main motivator for the performance.
Tournament theory relates to vertical pay dispersion because it suggests organisations where executive directors have a much higher level of pay will motivate other high-performing employees to work toward achieving the "prize", and has the additional organisational benefit of increased work effort and higher commitment to organisational goals.
In public sector organizations, the application of Tournament Theory is more complex. The emphasis on equity and fairness in public service contexts often contradicts the high pay differentials that the Tournament Theory suggests. Public sector organizations are expected to uphold public service values. and excessive vertical pay dispersion could determine those values. Public sector organizations may adopt a more balanced approach that integrates both tournament incentives and equity theory. In public sector, equity values are critical. The article highlights that large pay gaps, as suggested by Tournament Theory, may be perceived as unfair by employees, leading to reduce trust and organizational commitment. Therefore, in public sector settings, there is a need to balance the motivating effects of pay differentials with the importance of fairness and distributive justice (Keppeler and Papenfuß, 2021, p. 1849-1850).
Tournament theory assumes that large pay disparities encourage employees to compete for better positions. However, cognitive dissonance theory suggests that when faced with seemingly unachievable rewards (like very high executive salaries), employees might engage in a "sour grapes" rationalization. According to Kroll and Porumbescu (2107), " expectations of low extrinsic rewards led to higher reported intrinsic and prosocial motivation". This suggests that employees who perceive top positions as unattainable might devalue the importance of higher pay and instead focus on intrinsic aspects of their current roles. Such cognitive adjustments could decrease the motivational effects predicted by tournament theory, especially for employees who consistently fail to win promotions. Organizations implementing tournament-style structures should be aware of this potential "sour grapes" effect and consider ways to maintain motivation across all levels of the hierarchy.
Tournament structures may lead employees to adjust their preferences and motivation in response to expectations about rewards. When employees expect few extrinsic rewards. they may empathize with intrinsic motivations as a way to rationalize their work (Kroll& Porumbescu, 2017, p. 479).
Employees may cognitively adjust their reported levels of intrinsic and prosocial motivation as a coping mechanism when faced with low expectations of extrinsic rewards in tournament-like structures (Kroll & Porumbescu, 2017, p. 478).
Expectations of low extrinsic rewards in tournament settings can lead to higher reported levels of intrinsic motivation, as employees seek to justify the value of their work (Kroll & Porumbescu, 2017, p. 480).
While tournament theory focuses on short-term performance improvements, the long-term effect on employee motivation and organizational commitment may need further consideration. Understanding cognitive dissonance effects can inform the design of more effective tournament structures that balance extrinsic incentives with intrinsic and prosocial motivations(Kroll & Porumbescu, 2017, p. 483).

### Equity theory

Employees are interested and motivated to understand what the differences in pay are between themselves and their colleagues in an organisation, and to understand the difference between themselves and those in executive director positions. Equity theory is a more socialised approach toward understanding the effects of vertical pay dispersion in an organisation, than tournament theory.
Equity theory is based on the idea that individuals will evaluate the perceived fairness of their workplace or job by assessing the ratio of their work inputs to the outcomes they receive. They then compare their ratio to the ratio of others within the organisation. The research on equity theory suggests when individuals perceive the ratio of their work inputs as equivalent and fair in comparison with the ratio of others, pay equity is present in the organisation.
From the perspective of equity theory, vertical pay dispersion is a matter of a fair and equitable distribution of resources and a sense of justice in how the resources have been distributed within the organisation.

## Equity-based compensation

Equity-based compensation is an employer compensation plan using the employer's shares as employee compensation. The most common form is stock options, yet employers use additional vehicles such as restricted stock, restricted stock units (RSU), employee stock purchase plan (ESPP), performance shares (PSU) and stock appreciation rights (SAR). A stock option is defined as "a contract right granted to an individual to purchase a certain number of shares of stock at a certain price (and subject to certain conditions) over a defined period of time." Performance shares (PSU) awards of company stock given to managers and executives only if specified organization performance criteria are met, such as earnings per share target

## Intangible benefits

An employee may receive intangible benefits, such as a desirable work schedule. That could be a schedule that is controlled by the employee and can be adjusted to accommodate occasional non-work activities, or one that is highly predictable, which makes it easier for the employee to arrange childcare or transportation to work.
In New Zealand, many government organisations offer flexible work arrangements as part of their benefits. This may include flexible workplace arrangements or flexible time. Flexible workplace may include working from a remote workplace (usually a home office) for anything from 2 – 5 days per week. Flexi-time arrangements are beneficial for employees who have school going children or other commitments. These could include reduced hours, hours completed outside of normal work hours i.e. 40 hours per week but just not between the traditional 8am to 5pm. Other flexi-time arrangements include what is known as an 80 hour fortnight – usually a 9 hour day for 9 days and then the 10th day taken as time in lieu.
Access to training programs, mentorship, opportunities to travel or to meet other people in the same field, and similar experiences are all intangible benefits that may appeal to some employees.

### Intangible Benefits Associated with Public Sector Employment

Intangible benefits play a key role in public sector emplyment, often compensating for potentially lower extrinsic rewards compared to the private sectors. These benefits can include flexible work arrangement, such as those offered by many New Zealand government organizations, which may involve remote work options or flexible schedules to accommodate employee's personal needs. Other intangible benefits may include opportunity to get training programs, mentorship support, and the chance to contribute to societal wellbeing. Keppeler and Papenfuß (2021) highlight how these intangible benefits align with public sector values, particularly equity, Thy note that "Organization with a higher degree of public sector values in organizational practices such as pay policies" (p. 1852).
Furthermore, research by Kroll and Porumbescu (2017) provides additional insight into the relationship between extrinsic rewards and intrinsic motivation in public sector settings. The study discovered that when people were told they might expect limited extrinsic benefits in a public sector career, they reported higher levels of intrinsic drive. The authors propose that this is cognitive coping mechanism in which employees explain the worth of their jobs when extrinsic rewards are limited. According to Kroll and Porumbescu (2017, p 478), "expectations of low extrinsic rewards led to higher reported intrinsic and prosocial motivation". This suggests that intangible rewards, such as finding significance in one's work, might serve as compensatory motivations when monetary incentives are limited. These findings highlight the complex link between extrinsic an intrinsic rewards in public sector organizations and suggest that intangible benefits may play a key role in shaping employee motivation, especially when extirnsic rewards are limited.

## Intrinsic and extrinsic rewards

Self determination theory (SDT) suggests that people in the workplace are generally motivated by either intrinsic or extrinsic rewards or rather lie on a continuum between the two.
Extrinsic rewards are tangible or visible rewards and can include financial compensation (salary, wages, bonuses etc.) and promotion.
In their book "The 5 Languages of Appreciation in the Workplace", Gary Chapman and Paul White suggest that employees have preferred or dominant "language" when appreciation is expressed extrinsically. They identify the following extrinsic rewards:
1. Words of affirmation – this can be praise for an accomplishment, affirming character or praise for a personality trait. These can be given very publicly, within a team or privately depending on the recipient.
2. Quality time – This is giving of your most precious commodity - time – to express appreciation.
3. Acts of service – doing something for an employee, or colleague to express your appreciation for them.
4. Tangible gifts – this can be as simple as buying an employee or colleague a cup of coffee or giving them some time off as a gift for work well done.
5. Physical touch – this can be a high five or handshake (be careful!!!)
In all of these they caution on the need to maintain the appropriateness of the interaction.
Intrinsic rewards refer to internal factors that motivate a person to undertake work or a task. These can include a sense of accomplishment, learning and personal growth, creativity or work that gives one purpose and meaning.
Research shows that public employees placed higher value on intrinsic rewards, particularly if they elevated or high levels of Public Service Motivation (PSM). PSM can be defined as "an individual's predisposition to respond to motives grounded primarily or uniquely in public institutions and organizations". This concept has been correlated with numerous variables such preferences for reward, job satisfaction, commitment and performance. Literature suggests that an increased level of PSM is associated with an individual's desire to serve in the public interest. Public employees placed a significantly higher value on work that is helpful to society over their private sector counterparts. They also valued interesting work and job security. A significant positive correlation exists between PSM, job satisfaction, performance and commitment. Despite this, research has found that extrinsic rewards can be important in both public and private organisations.
Extrinsic rewards can be effective in motivating people, especially in situations where the task or behaviour may not be inherently enjoyable or when a specific outcome needs to be achieved. However, relying too much on external ort extrinsic rewards can actually lead to a decrease in internal or intrinsic motivation, or the desire to do something because it is enjoyable or rewarding in itself. If people come to expect external rewards for everything they do, they may lose their natural interest and internal drive for the task itself. However, it's important to note that overreliance on extrinsic rewards can sometimes lead to a decrease in intrinsic motivation[5]. If people come to expect external rewards for everything they do, they may lose their natural interest and internal motivation for the task itself.
Balancing extrinsic and intrinsic motivation is often essential for promoting sustained interest and engagement in activities and behaviours. Effective motivation strategies take into account the individual's unique needs and preferences, while also recognizing the role that both types of rewards play in influencing behaviour. It is important to achieve the right blend of intrinsic and extrinsic rewards within the overall compensation and benefits offered to an employee.

## Pay aggregates

Various combinations of the above four categories are referred to as pay aggregates. Common aggregates are explained below.
Together, guaranteed and variable pay comprise total cash compensation. The ratio of base salary to variable pay is referred to as the pay mix. For example, a person receiving a bonus equal to 25% of base salary would have an 80/20 pay mix. Organizations often set the total cash compensation for sales people at a market level, then they split the total cash compensation into the base salary component and the incentive component following a 70/30 pay mix, while other (non-sales) employees may have a 90/10 pay mix.
Total guaranteed package or fixed cost to company are aggregates that include guaranteed pay and benefits. This represents the total fixed cost of the reward package and is useful for budgeting. All forms of variable pay (annual bonus and equity compensation) are excluded from this aggregate.
Total direct pay refers to total cash compensation plus equity compensation. Benefits are excluded from this aggregate. Total direct pay includes all the elements that may be negotiated by a job candidate, especially for senior executive positions where annual and long-term incentives are more substantial.
Total compensation would include all four categories: guaranteed pay (salary and allowances), variable pay, benefits and equity compensation.
Remuneration is a term often used to refer to total cash compensation or total compensation.
As noted above, total rewards would include total compensation as well as intangible benefits such as culture, leadership, recognition, workplace flexibility, development and career opportunity.

### External equity

External equity refers to the similarity of the practices of other organization of the same sector. If perceived like this, it can be said that the program is considered competitive or externally equitable. Usually, these comparisons are done in external labor markets where the wages vary. There are various factors that contribute to create these differences, for example, geographical location, education and work experience.

### Internal equity

Internal equity is employees' perception of their duties, compensation, and work conditions as compared with those of other employees in similar positions in the same organization. As this comparison is always made within the company, problems with internal equity can result in conflict among employees, mistrust, low morale, anger and even the adoption of legal actions. Workers can make the evaluation of internal equity regarding two main points. On the one hand, procedural justice is the person's perceived fairness of the process (assigned tasks) and procedures used to make decisions about him/her. On the other hand, distributive justice refers to the perceived fairness in the distribution of outcomes (salaries). The classic objectives of equity based compensation plans are retention, attraction of new hires and aligning employees' and shareholders' interests with the long-term success of the company.

## Organizational place

In most companies, compensation & benefits design and administration falls under the umbrella of human resources.
HR organizations in large companies are typically divided into three sub-divisions: HR business partners (HRBPs), HR centers of excellence, and HR shared services. Compensation & benefits is an HR center of excellence, like staffing and organizational development.

## Main influencers

There are various internal and external elements that influence employee compensation and benefits, which also outlines the workforce dynamics as well as organizational strategies. In order to create an equitable and competitive compensation packages it is pivotal to fathom these influencers.
Internal Influencers
1. Business Objectives: the companies take into consideration the comprehensive business target and integrate their compensation approaches. For instance, in order to incentivize creativity, firms that are targeting to stimulate innovation may provide bonuses based on performance. Alternatively, a firm focusing on cost leadership may tend to embrace more consistent pay structures in order to decrease costs.
2. Labor Unions: collective bargaining is an important tool used to shape the compensation and benefits in organizations with unions. With the aim of achieving enhanced pay, benefits and working environments, unions on behalf of the employees negotiate and manipulate the company's compensation plans.
3. Internal Equity: for employees executing comparable tasks, organizations endeavor to preserve fairness among them. The main aim of internal equity is to improve morale as well as decrease turnover by making the employees feel appreciated comparative to their coworkers. Pay differences can result in disappointment and decline in productivity levels.
4. Organizational Culture: an organizations compensation strategies is determined by its vital beliefs and values. Inclusive benefits such as health promotion programs and variable work schedules may be offered to employees whose organization culture promotes employee well-being, whereas an organization with tradition culture mainly may emphasis on pay.
5. Organizational Structure: the compensation structure is influenced by the chain of command and organizational design. There may be small difference in pay bands in flat organization however the hierarchical structures have variations in pays in accordance to the seniority and position. Hence, this can affect the development of pay bands.
External Influencers
1. State of the Economy: the compensation strategies are substantially influenced by economic conditions. In order to entice qualified applicants, organizations in a thriving economy may provide higher pay and benefits. Conversely, in times of economic downturns organizations may be compelled to reduce pay and benefits in order to address costs.
2. Inflation: higher rates of inflation decreases the purchasing ability and also compels organizations to accordingly set the pay levels. With the aim to preserve the employees' living standards and maintaining labor market competitiveness, employers may introduce cost of living adjustments (COLAs).
3. Unemployment Rate: as a result of high labor availability due to increased unemployment figures, organizations may propose lower pay. Similarly, a competitive employment landscape is created with decreased unemployment figures, compelling organizations to propose higher compensation packages in order to entice and preserve high qualified applicants.
4. The Relevant Labor Market: there are frequent comparison of compensation polices with the area salary statistics as well as the industry benchmarks. It is important that organizations are aligned to the market movements in order to maintain competitiveness, particularly the sectors that has high demands and shortage of talent.
5. Labor Law: often the baseline compensation policies and practices are shaped by the legislations related to employee benefits, minimum wage rates and the overtime pay. In order to preserve a good reputation and prevent legal consequences, it is vital that there is compliance with labor laws.
6. Tax Law: with tax regulations the employer is influenced to furnish essential benefits like retirement plans and health insurance. Tax enticements impacts the whole compensation practices by encouraging employers to facilitate necessary benefits.

## Bonus plans benefits

Bonus plans are variable pay plans. They have three classic objectives: 1. Adjust labor cost to financial results – the basic idea is to create a bonus plan where the company is paying more bonuses in good times and less (or no) bonuses in bad times. By having bonus plan budget adjusted according to financial results, the company's labor cost is automatically reduced when the company isn't doing so well, while good company performance drives higher bonuses to employees. 2. Drive employee performance – the basic idea is that if an employee knows that his/her bonus depend on the occurrence of a specific event (or paid according to performance, or if a certain goal is achieved), then the employee will do whatever he/she can to secure this event (or improve their performance, or achieve the desired goal). In other words, the bonus is creating an incentive to improve business performance (as defined through the bonus plan). 3. Employee retention – retention is not a primary objective of bonus plans, yet bonuses are thought to bring value with employee retention as well, for three reasons: a) a well designed bonus plan is paying more money to better performers; a competitor offering a competing job-offer to these top performers is likely to face a higher hurdle, given that these employees are already paid higher due to the bonus plan. b) if the bonus is paid annually, employee is less inclined to leave the company before bonus payout; often the reason for leaving (e.g. dispute with the manager, competing job offer) 'goes away' by the time the bonus is paid. the bonus plan 'buy' more time for the company to retain the employee. c) employees paid more are more satisfied with their job (all other things being equal) thus less inclined to leave their employer.
The concept saying bonus plans can improve employee performance is based on the work of Frederic Skinner, perhaps the most influential psychologist of the 20th century. Using the concept of Operant Conditioning, Skinner claimed that an organism (animal, human being) is shaping his/her voluntary behavior based on its extrinsic environmental consequences – i.e. reinforcement or punishment.
This concept captured the hearts of many, and indeed most bonus plans nowadays are designed based on it, yet since the late 1940s a growing body of empirical evidence has suggested that these if-then rewards do not work in a variety of settings common to the modern workplace. The failings of the bonus plan often relate to rewarding the wrong behaviour. For example, managers who keep to the status quo, fire valuable (expensive) employees, and engage in immoral business practices can achieve better short-term financial outcomes (and therefore a bonus) than a manager who is attempting to innovate his or her way to higher profits. When bonus plans are poorly thought out, they have the potential to damage employee performance and cause regulatory headaches. However, despite their failings, employees (and many employers) still view an effective bonus plan as the single greatest motivator in the workplace.