Compensation: Definition, function, significance


According to the viewpoint of the economist, labour only sells its services to the entrepreneur for productive purposes; does not sell itself.

As such, any payment made to this factor of production (i.e. labour) is only in the nature of compensation for its services.

Moreover, the services provided by labour are invaluable, in the sense that without such services, the productive machinery is like a body without any soul. Therefore, labour could not be paid exactly for its services; any payment to it is only a mere compensation of the value provided by it to the production mechanism.

Payment or compensation to labour for its services is popularly known as personnel remuneration. This payment is variously called either wages or salaries. Though in reality, the concept of wages and salaries are not much different so far as their determination and significance are concerned; yet it would be an interesting academic exercise to differentiate the two.

Wages are usually associated with a payment made to workmen who are actually engaged in physical production of goods and services; and payment of wages being made on both bases-time rate and piece rate systems.

Salaries, on the other hand, represent a payment made to office employees, managerial personnel and technical personnel like engineers, cost accountants, etc.; and salaries usually being paid only on a time-basis i.e. according to time-rate system of payment.

The term compensation is used to indicate the employee’s gross earnings in the form of financial rewards and benefits.

Compensation can also be defined as follows:

  1. A system of rewards that can motivate the employees to perform.
  2. A tool that is used to foster values and culture.
  3. An instrument that enables an organization to achieve its objectives.

The management should ensure that compensation structure is designed after taking into account certain factors such as qualification, experience, attitude and prevailing rates in the markets. Compensation means the reward that is received by an employee for the work performed in an organization. It is an important function of human resource management. Employees may receive finan­cial and non-financial compensations for the work performed by them.

Financial compensation includes salary, bonus, and all the benefits and incentives, whereas non-financial compensation includes awards, rewards, citation, praise, recognition, which can motivate the employees towards highest productivity.

Compensation System:

Compensation is a tool used by management for safeguarding the existence of the company. Compensa­tion can be of two types—direct and indirect.

(i) Direct Compensation:

  1. Basic pay, dearness allowance, cash allowance
  2. Incentive pay, bonus, commission, profit sharing, stock option.

(ii) Indirect Compensation

  1. Legal requirement
  • Provident fund
  • Gravidity
  • Pension
  • Insurance
  • Medical leave
  • Accident benefits
  • Maturity leave
  1. Optional sick leave
  2. Casual leave
  3. Travelling allowance
  4. Telephone bills
  5. Canteen allowance
  6. Club membership

The main characteristics of the compensation system are as follows:

  1. A hierarchy of pay levels
  2. A hierarchy of jobs
  3. A set of rules and procedures
  4. Qualities required for movement from one level to other

An organization’s compensation system usually consists of three separate components. Each element of the compensation package has a link with an individual need hierarchy. All allowance are linked to basic pay. In order to motivate the employees when they achieve objectives, rewards and incentives are incorporated along with basic pay. To retain the employees and to get long-term commitments, stock option plan, annual increments and promotion are provided.

Objectives of Compensation:

  1. The compensation should be paid to each employee on the basis of their abilities and training.
  2. Compensation should be in the form of package.
  3. It should motivate the employees towards increasing productivity.
  4. It should be capable of taking care of employees for safety and security needs also.
  5. It should be flexible and clear.
  6. It should not be excessive.
  7. Compensation should be decided by the management as per the norms fixed by the legislations in consultation with the union.

Significance of Employee Compensation (Or Personnel Remuneration):

The issue of personnel remuneration, whether in the form of wages or salaries, is highly significant from the viewpoint of industrial relations, social peace and economic implications. In fact, it is the centre from which the circle of industrial relations is drawn; it being the crux of industrial conflicts.

Following are some of the points which highlight the significance of personnel remuneration:

(i) Wages/ salaries constitute the primary source of income to employees. Their adequacy or otherwise would very much determine their standard of living.

(ii) Adequate remuneration is a source of motivation to employees. It makes them committed and loyal to the organization; and paves way for excellent industrial relations.

(iii) Through making adequate and timely payment of employee remuneration, an employer can attract and retain good personnel to and in the organization. This helps to ensure a stability of labour force – bringing several valuable advantages in the its wake for the organization.

(iv) Specially, in labour-intensive industries, wages constitute a substantial part of the cost of production. As such wage payments affects the cost and price-structures of an industrial enterprise. Prices of goods and services, in turn, have social implications; as these directly affect the purchasing power of money held by the society.

3 thoughts on “Compensation: Definition, function, significance

Leave a Reply

error: Content is protected !!
%d bloggers like this: