Compensation Definition: A Guide to Pay

Key takeaways

Compensation plays a key role in a company’s ability to attract and retain employees when accepting a job offer and deciding to stay with a job.

• Employee compensation may be direct, in the form of pay and bonuses; indirect, in the form of paid time off or health insurance; or non-monetary, in the form of training, flexible schedules, and other benefits.

• Compensation is beneficial because it can attract top talent and retain and motivate employees.

• You can work as a compensation and benefits manager as part of a human resources (HR) team to oversee employee compensation.

Discover the definition of compensation, explore the three types of employee compensation, learn how a fair compensation package helps companies, and more. If you’re ready to develop your HR skills, consider enrolling in the Human Resource Management: HR for People Managers Specialization from the University of Minnesota. You’ll have the opportunity to learn the best practices for hiring and rewarding employees in as little as two months. By the end, you’ll have gained in-depth HR knowledge that will prepare you for your career.

Compensation definition: What is it?

Compensation refers to monetary and non-monetary payments that organizations provide employees in exchange for work performed. Offering fair compensation plans, including a mix of monetary and non-monetary types of compensation, helps attract, motivate, and retain employees. 

You can also apply the term to payments for harm that someone has suffered from an accident or illness. This article provides more information specific to the compensation provided by employers.

3 types of employee compensation

Companies have three options when choosing their employee compensation structures: direct, indirect, and non-monetary.

1. Direct compensation

When workers receive monetary compensation for completed work, it falls under the category of direct compensation. Employees can receive four different kinds of direct compensation: hourly pay, salary, commission, and bonuses. 

• Hourly pay: A certain amount of income received for every hour worked

• Salary: A set amount of money paid to an employee over the course of a year, regardless of hours worked 

• Commission: An extra fixed amount of money paid to an employee based on a percentage of sales

• Bonuses: An extra variable amount of money paid to an employee for work above and beyond the job description

2. Indirect compensation

Indirect compensation refers to non-cash forms of compensation. Examples of indirect compensation "paid" to employees include:

• Childcare

• Company cars

• Employer retirement contributions

• Health or life insurance

• Work-related equipment like laptops and smartphones

3. Non-monetary compensation

This type of compensation refers to rewards and advantages employees receive without monetary value. Examples of non-monetary compensation include:

• Public recognition, such as an employee of the month award

• Time off for community work or volunteering

• An option for flexible work hours

• An open-door policy for manager access and constructive feedback

• Mentorship programs 

• Opportunities for training and attending other work-related events

Is compensation the same as salary?

While related, compensation and salary are not the same. Salary is the amount of money you earn on an annual basis to perform your job duties. Compensation includes your salary, along with additional benefits, such as bonuses, commissions, paid time off, health insurance benefits, and more.

Why is employee compensation important?

As mentioned, adequate compensation helps attract potential employees and keeps current employees motivated and loyal. Companies benefit from attraction, motivation, and retention in the following ways:

Benefits of attracting top talent

A good compensation strategy helps attract potential employees. A large talent pool of potential employees helps ensure a skilled and qualified staff. 

Benefits of employee motivation

Employees who receive adequate compensation often have higher morale and job satisfaction. High morale frequently leads to higher motivation to work and perform better. 

Benefits of employee retention 

When employees want to come to work, they're more likely to stay longer in the position. Retaining skilled, motivated employees saves companies money. 

Factors that impact compensation

Creating a fair compensation structure sometimes proves challenging for employers. Employers evaluate several factors to determine fair compensation for workers. These include:

• Employee education

• Employee skills and experience

• Current market trends for employee compensation

• Geographic location and how it affects the cost of living

• Employee productivity

• Labor supply and demand

• Labor union requirements

• Financial health of the company

What is a compensation and benefits manager?

A compensation and benefits manager oversees any activities within an organization that involve employee compensation and benefits. Duties in this job might include setting and monitoring a company's pay and benefits structure, managing pay and benefits distribution, ensuring compliance with state and federal laws and regulations, and working with outside benefits and insurance professionals. 

According to Glassdoor, the median total pay for a compensation and benefits manager totals $160,000 [1]. This figure includes base salary and additional pay, which may represent profit-sharing, commissions, bonuses, or other compensation.

Essential skills needed by a compensation and benefits manager

All jobs demand a particular skill set for effective job performance. Essential skills that can help you perform better in the role of compensation and benefits manager include:

• Ability to think analytically

• Attention to detail

• Business acumen

• Communication skills

• Decision-making skills

• Familiarity with compensation and benefits software

• Knowledge of company policies and procedures

• Organizational skills

• Problem-solving skills

• Time management

How to become a compensation and benefits manager

A blend of education and experience can help increase your competitive standing as a prospective compensation and benefits manager. Examine three helpful qualifications that can support your goals. 

Get a bachelor's degree. 

Employers hiring a compensation and benefits manager typically look for someone with a bachelor's degree. Excellent areas of study for this position include:

• Business administration

• Business management

• Finance

• Human resources

Read more: How to Get a Bachelor’s Degree: Requirements to Graduate

Get work experience.

Typically, you can expect to start in an entry-level position and work up to a compensation and benefits manager role. Examples of entry-level positions that can help give you the experience for this job include assistant, coordinator, or specialist positions in benefits, compensation, payroll, or job analysis. An entry-level business, management, finance, or human resources position can also help lead you down this career path.

Get certifications. 

Once you have a few years of job experience, you can get certifications to become even more prepared for a compensation and benefits manager job. Professional associations that offer certifications you might want include the International Foundation of Employee Benefit Plans and the Society for Human Resource Management. 

Examples of related jobs

To get an idea of all the types of jobs in this field, consider exploring related roles. Jobs with similar duties and skill requirements to those of a compensation and benefits manager include:

• Compensation, benefits, and job analyst

• Financial manager

• Human resource manager

• Human resource specialist

• Labor relations specialist

• Payroll administrator

• Payroll specialist

• Payroll processor

• Training and development manager

• Training and development specialist

Find helpful resources for your career

Read about industry trends and discover helpful career tips by subscribing to Career Chat, our LinkedIn newsletter. Then, explore these resources for additional guidance:

• Broaden your knowledge: GenAI for HR: Use Cases and Benefits 

• Watch on YouTube: 7 Key Communication Skills to Thrive in Your Career 

• Take a quiz: Career Test: What Career Is Right for Me Quiz? 

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