How Is Compensation Determined for an Employee?

Understanding Your Job Offer or Your Current Compensation

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Compensation is defined as the total amount of the monetary and non-monetary pay provided to an employee by an employer in return for work performed as required. Essentially, it's a combination of the value of your pay, vacation, bonuses, health insurance, and any other perk you may receive, such as free lunches, free events, and parking. These components are encompassed when you define compensation.

How Is Compensation Determined?

Companies base compensation on numerous factors. Some companies pay more attention to the following factors than others do but almost all companies use some form of analysis to set compensation.

Market research about the worth of similar jobs in the marketplace: Numerous companies do formal salary surveys that can help companies determine the market rate of a job. In these salary surveys, companies report their current pay and benefits for jobs based on the job description.

The survey company then compiles the data and reports it back to the participants. These findings can be extremely accurate. They provide good insight into the competitive rates employers are paying in the marketplace for the employees performing the same or similar job duties.

There are also online database websites for salary information, where data is collected nationally and internationally.

These sites such as Payscale.com and Salary.com provide recommended salary ranges taking into consideration factors such as the job market, the location of the job, the size of the company offering the job, and the job duties and responsibilities. 

Payscale.com is recommended for its accuracy in the midwest.

According to PayScale.com, "PayScale links individuals and businesses to the largest salary profile database in the world."

Other companies look at the data that is available on the internet, from websites like Glassdoor.com. The data is not as accurate as that of a salary survey because they are self-reported by the employees. They are not comprehensive on all of the components of an employee compensation package either.

The job descriptions these salaries are based on are not as detailed as the ones in the salary surveys. Two people with wildly different responsibilities in two different companies may have identical titles, resulting in confusion as to what the appropriate compensation really should be for the employee.

It is also critical to consider local economies and company size. For instance, you will need to pay an administrative assistant to the CEO of a Fortune 100 company in New York City considerably more than the administrative assistant to the CEO of a company with 30 people in a small town in Iowa. Their job titles are identical—Administrative Assistant to the CEO—but their pay is completely different.

Employee contributions and accomplishments: You want your star employee to make more than your slacker employee, even if they have the same title.

Companies recognize the difference in how much an employee contributes to the company through pay differentiation with merit increases going to their best. (But, ask yourself with some honesty, if you determine an employee is unworthy of compensation increases, why are you employing this individual?)

The availability of employees with like skills in the marketplace: When only one person in the town has a particular skill and two companies need that skill, the bidding wars can start. When only one company needs a particular skill and has two people to choose from who can both do it, they don't need to pay the employee as much money. The organization with alternatives does not need to compensate the chosen employee with more than the going market rate.

The desire of the employer to attract and retain a particular employee: If a company really wants a particular employee, then they'll pay more.

If a company has a reputation as a horrible place to work, they may need to pay more to attract employees, for example. 

The profitability of the company or the funds available in a non-profit or public sector setting: Often, non-profit or public sector businesses pay less. People are willing to work for them anyway because they believe in the mission and vision of the organization. The work of the organization may be consistent with their own personal values.

Or, in the case of government employment and unionized workplaces, the employees may value their job security and expected increases in an increasingly volatile world—more than they value increased compensation.

Some public sector jobs have low paychecks, but high benefits, such as health insurance and pensions. With compensation, you need to look at the whole picture in both the public and the private sectors.

Previous salaries: Basing your salary offer on an employee's previous salaries is a horrible way to determine a salary for a new employee. (And nationally, in a number of locations, it is now illegal.) But many companies look at your salary from your last job and increase it by a small percentage. This can result in unfair compensation and discord within the company.

For example, when Bob was making $50,000 at company A and gets a 10 percent raise to come on board, he's probably happy with his $55,000. But, when he finds out that Jane, who has the same title and responsibilities, is making $66,000 a year because she was earning $60,000 at her previous company, he'll be angry.

He may claim that the reason for the discrepancy is gender discrimination, and the company will be forced to prove otherwise.

Compensation also includes payments such as bonusesprofit sharing, overtime pay, recognition rewards and checks, and sales commission. Compensation can also include non-monetary perks such as a company-paid car, stock options in certain instances, company-paid housing, and other non-monetary, but taxable, income items.

Compensation is a fascinating topic, because, face it, people have various reasons for working, but the bottom line is that most employees work for money. It is in the best interests of an employee to try to receive more compensation. It is in the best interests of an employee to work their way up the corporate ladder to the executive level so that they can earn increasingly more money.

It's not in the best interests of an employer to have disgruntled, unhappy employees who feel they are underpaid. But, offering fair market compensation with generous benefits should help the employer make his wish come true—a thriving, contributing workforce in sync with the business aims and needs.