Compensation

This text looks at salary and bonuses, benefits, insurance, long-term incentive plans, and paid expenses. Some companies offer employee stock options believing that they incentivize employees with an ownership stake in the firm to boost the company's stock price (ordinarily a function of firm performance). Managers may use some of these tools when organizational systems govern salary.

Forms of Financial Compensation

Compensation is a monetary benefit given to workers in return for services provided by them and it can take a number of different forms.


Learning Objectives

Explain each part of a total rewards system including salary, benefits, incentive pay, and an employee stock option (ESO)


Key Takeaways

Key Points
  • There are six basic forms of compensation: salary, short-term incentives (STIs or bonuses), long-term incentive plans (LTIPs), benefits, paid expenses, and insurance.
  • Short-term incentives are usually formula-driven, whereas bonuses are awarded after-the-fact and are usually discretionary.
  • Wages are given to workers whereas salaries are given to employees. They are both affected by market forces, as well as other factors, such as tradition, social structure, or government regulation (e.g., minimum wage laws).
  • Executive pay is usually a mixture of these different forms of compensation, with a salary, bonuses, benefits and expenses, and shares or call options on company stock.
  • Salaries are often seen as part of a "total rewards" system that includes benefits and perquisites.
  • Employee stock options (ESOs) are sometimes offered to management, with the objective of giving them an incentive to behave in a way that boosts the company's stock price.
Key Terms
  • salary: A fixed amount of money paid to a worker, usually measured on a monthly or annual basis, not hourly, as wages. Implies a degree of professionalism and/or autonomy.
  • perquisite: Any monetary or other incidental benefit beyond salary.


There are six basic tools of compensation or remuneration:

  • Salary
  • Short-term incentives (STIs), sometimes known as bonuses
  • Long-term incentive plans (LTIP)
  • Employee benefits
  • Paid expenses (perquisites)
  • Insurance

A salary is a form of remuneration paid periodically by an employer to an employee, the amount and frequency of which may be specified in an employment contract. From a business point of view, salary can be deemed as the cost of acquiring human resources for running operations and is then termed personnel expense or salary expense.

Salary: A salary is a form of remuneration paid periodically by an employer to an employee, the amount and frequency of which may be specified in an employment contract.

In accounting practice, salaries are typically recorded in payroll accounts. While there is no first pay stub for the first work-for-pay exchange, the first salaried work would have required a human society advanced enough to have a barter system to allow work to be exchanged for goods or other work. More significantly, it presupposes the existence of organized employers - perhaps a government or a religious body - that would facilitate work-for-hire exchanges on a regular enough basis to constitute salaried work.

Today, the idea of a salary continues to evolve as part of a system of all the combined rewards that employers offer to employees. Salary (also now known as fixed pay) is coming to be seen as part of a "total rewards" system, which includes bonuses, incentive pay, and commissions, benefits and perquisites (or perks), and various other tools which help employers link rewards to an employee's measured performance. An employee stock option (ESO) is a call option on the common stock of a company, granted by the company to an employee as part of the employee's remuneration package.

The objective is to give employees an incentive to behave in ways that will boost the company's stock price. If the company's stock market price rises above the call price, the employee would exercise the option, pay the call price, and would be issued with ordinary shares in the company. The employee would experience a direct financial benefit of the difference between the market and call prices. If the market price falls below the stock call price at the time the option needs to be exercised, the employee is not obligated to call on the option, in which case the option will lapse.

Restrictions on the option (such as vesting and limited transferability) attempt to align the holder's interest with those of the business shareholders. Employee stock options are mostly offered to management as part of their executive compensation package. They may also be offered to non-executive level staff, especially by businesses that are not yet profitable, insofar as they may have few other means of compensation.

Alternatively, employee-type stock options can be offered to non-employees: suppliers, consultants, lawyers, and promoters for services rendered. Employee stock options are similar to warrants, which are call options issued by a company with respect to its own stock.

Source: Lumen Learning, https://courses.lumenlearning.com/boundless-business/chapter/compensation/
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