Chapter 1
A Road Map to Effective
Compensation
Copyright © 2021 by Top Hat 1-1
Learning Outcomes
(Slide 1 of 2)
• Describe the key purpose of a compensation system.
• Explain why an effective compensation system is
important to most organizations.
• Distinguish between extrinsic and intrinsic rewards.
• Distinguish between a reward system and a
compensation system.
• Describe the key aspects of a compensation strategy.
1-2
Learning Outcomes
(Slide 2 of 2)
• Explain why a compensation system must be viewed
in the context of the total reward system,and the
broader environment of the organization.
• Understand the key criteria for evaluating the success
of a compensation system.
• Describe the steps along the road to effective
compensation and explain how this book will
facilitate that journey.
1-3
Importance of
Compensation Systems
• Help achieve strategies and objectives
• Help attract, retain, and motivate employees
• Have philosophical and moral implications
• Influence standard of living
• Influence financial value of the pay system to
the organization’s bottom line
• Address internal and external equity issues
1-4
Assessment Question 1.1
The meaning of compensation may be different from
stakeholder to stakeholder. For employees, which of
the following is an important aspect to consider?
a) Value of compensation system to the job candidates
b) High compensation costs as a percentage of firm’s
total expenses
c) The level of alignment of compensation system with
firm’s strategy
d) Take home pay
Copyright © 2021 by Top Hat 1-5
Compensation System:
Asset or Liability?
• Typically 40–70 percent of operating budgets
compensate employees
• Single largest operating expenditure
• Canadian employers spend over a trillion dollars
on wages and salaries
• Too much? Too little?
What is the organization receiving for its
investment in wages, salaries, and benefits?
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Purpose of the Compensation
System
• How do you get organization members to do
what the organization wants and needs them
to do?
– Compensation is a key part of the solution
– Purpose
• To help create a willingness among qualified persons to
join the organization and to perform the tasks needed
by the organization
Copyright © 2021 by Top Hat 1-7
Role of
the Compensation System
• Employees must perceive that accepting a job
with a given employer will help them satisfy
some of their own important needs
• Includes:
– Economic needs for the basic necessities of life,
needs for security, social interaction, status,
achievement, recognition, and growth and
development
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Extrinsic vs. Intrinsic Rewards
Extrinsic Intrinsic
• Factors that satisfy • Factors that satisfy
basic human needs higher-order human
for: needs for:
– Survival – Self-esteem
– Security – Achievement
– Social needs – Growth
– Needs for – Development
recognition
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Rewards vs. Incentives
• Reward
– Positive consequences of performing behaviours
desired by the organization, and employees
normally receive these rewards:
• Subsequent to performing the behaviour
(extrinsic rewards)
• During performance of the behaviour (intrinsic
rewards)
• Incentive
– Promise that a specified reward will be provided if
employee performs a specified behaviour
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Rewards
Rewards include work/life balance.
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Components of the Rewards and
Compensation Strategies
• Organizations must consider the total
spectrum of rewards—as well as
compensation—known as total rewards
approach
Copyright © 2021 by Top Hat 1-12
Figure 1.1: Components of the
Rewards and Compensation Strategies
Total Rewards
Compensation Examples of Broader Rewards
• Career Advancement
• Base Pay
• Recognition Programs
• Performance Pay
• Positive Workplace Culture
• Indirect Pay
• Work/life Balance
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Reward and Compensation
Systems
• Reward systems:
– the mix of extrinsic and intrinsic rewards provided
by an organization
• Compensation system
– deals only with economic/
monetary part of reward
system
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the Bank of Canada
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Reward vs. Compensation Strategy
Performance
Intrinsic pay
Base pay
Extrinsic
Indirect
pay
Reward Compensation
system system
Copyright © 2021 by Top Hat 1-15
Reward Strategy
• A plan for the mix of rewards with the means
to be provided
• Must be developed before the compensation
system
• The reward strategy is the blueprint for
creating the reward system
Copyright © 2021 by Top Hat 1-16
Components of a Compensation System
Three main components:
1. Base pay: Foundation pay component for most
employees, generally based on a unit of time
worked
2. Performance pay: Employee monetary rewards
to some measure of performance
3. Indirect pay: Noncash items or services that
satisfy a variety of specific employee needs, such
as health protection or retirement security
• sometimes known as “employee benefits.”
Copyright © 2021 by Top Hat 1-17
Key Aspects of a Compensation Strategy
1. The mix across the three compensation
components, and whether and how this mix
will vary for different employee groups
2. The total amount of compensation to be
provided to individuals and groups
– How should compensation be paid?
– How much compensation should be paid?
1-18
Compensation Today 1.2
• When should interns be
paid?
• Can organizations get
away with providing no
compensation to
interns?
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Copyright © 2021 by Top Hat 1-19
Assessment Question 1.2
A compensation system usually deals with only
monetary part of the total reward system of an
organization. Which of the following does not
fall under compensation?
a. base bay
b. career advancement
c. performance pay
d. pension plan
Copyright © 2021 by Top Hat 1-20
Goals of the Compensation System
1. Promote achievement of the organization’s goals.
2. Fit with and support the organization’s strategy and
structure.
3. Attract and retain qualified individuals.
4. Promote desired employee behaviour.
5. Be seen as equitable.
6. Comply with the law.
7. Be within the financial means of the organization.
8. Achieve the above goals in the most cost-effective
manner.
Copyright © 2021 by Top Hat 1-21
Optimal Reward System
• Reward system that adds most value to the
organization after considering all its costs
• May not be the cheapest reward system
– In some cases, a high-wage compensation strategy
may suffice
1-22
Figure 1.2
A Road Map to Effective Compensation
Copyright © 2021 by Top Hat 1-23
A Road Map to Effective
Compensation
(Slide 1 of 3)
• Step 1:
– Understand organizational context: The reward
system is part of the total organizational system,
and must fit with and support the other parts
• Step 2:
– Determine mix of compensation components to
include and total level of compensation
components to include and total level of
compensation to provide, relative to other
employers
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A Road Map to Effective
Compensation
(Slide 2 of 3)
• Step 3:
– Establish the processes for determining actual
dollar values for jobs and for individual
employees
• Job evaluation
• Labour market surveys
• Performance appraisal
Copyright © 2021 by Top Hat 1-25
A Road Map to Effective
Compensation
(Slide 3 of 3)
• Step 4:
– Design your performance pay and indirect pay
plans
• Step 5:
– Key issues here include procedures for
implementing the system, communication
information about the system, dealing with
compensation problems, budgeting, and
controlling compensation costs
Copyright © 2021 by Top Hat 1-26
The Context of Compensation
Management
• Responsibilities usually reside with the owner
or CEO in smaller organizations; within HR in
larger ones
• Roles include job analysts, benefits specialists,
compensation analysts, and compensation
managers
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Certified HR Designations
• In nine provinces and three territories across
Canada (not including Ontario), successful
candidates are approved for the Chartered
Professional in Human Resources (CPHR)
designation.
• In Ontario, candidates are awarded the
Certified Human Resources Professional
(CHRP) designation
Copyright © 2021 by Top Hat 1-28
Assessment Question 1.3
In order to design an effective compensation
system for a company, which of the following
should serve as the last component?
a. Implementing and evaluating the system
b. Formulation and determining the budget
c. Understanding the organization and the
people
d. Designing pay plans
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Examples Of Jobs That Require
Compensation Knowledge
• Compensation Analyst
• Manager Of Compensation
• Vice President Of Human Resources
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Summary
(Slide 1 of 3)
• The goal of compensation systems is to encourage
qualified persons to join the organization and
perform the tasks required by the organization.
• Effective compensation systems are important to a
firm’s success.
• Extrinsic rewards are factors that satisfy basic human
needs while intrinsic rewards satisfy higher order
human needs for self esteem, achievement, growth,
and development.
Copyright © 2021 by Top Hat 1-31
Summary
(Slide 2 of 3)
• The reward system is the combination of intrinsic and
extrinsic rewards that an organization provides to its
members, whereas the compensation system only
addresses the economic or monetary component of the
reward system.
• The two most important aspects of a compensation
strategy are the mix of the three compensation
components, as well as whether and how this mix will
vary for different employee groups; and, the total
amount of compensation to be provided to individuals
and groups.
Copyright © 2021 by Top Hat 1-32
Summary
(Slide 3 of 3)
• The compensation system should be viewed in the
context of the overall reward system and the
organization larger environment.
• The “road map” to help you understand the design
and development of an effective compensation
system is described in Figure 1.2, A Road Map to
Effective Compensation
Copyright © 2021 by Top Hat 1-33