What is compensation? Definition and meaning

The definition and meaning of the term ‘compensation‘, in the world of business, may refer to to the direct and indirect benefits that a worker receives from an employer, or how much a wrongdoer has to pay a victim for the damage or injury caused by his or her actions or lack of action.

When it refers to an employee’s pay package, it is often called ‘compensation and benefits’. Successful employers develop programs that outline equitable processes to reward their workers and executives. A well-structured program with a good balance of rewards, benefits and wages will help employers remain competitive in the current labor market and ensure future sustainability.

According to the Cambridge Dictionary, compensation is:

“1. Money that is paid to someone in exchange for something that has been lost or damaged or for some problem. 2. The combination of money and other benefits (= rewards) that an employee receives for doing their job.”

Executive CompensationExecutive compensation is the pay + benefits package provided to senior executives, which is generally different from what is offered to the rest of the workforce. Stock options are commonly used as a management incentive.

Compensation paid for work and what it is?

Compensation is a systematic approach to providing monetary value to workers in exchange for the work they do. It may achieve several purposes – helping fill job vacancies, work performance, and job satisfaction.

Essentially, it consists of a combination of an employee’s pay, vacation, health insurance, bonuses, and other perks they may receive, such as a company car, free parking, free or subsidized meals, commuting costs, etc.

Employers base compensation on a number of factors. Some companies get together and carry out salary surveys that can help them determine what the market rate is for a job. The survey firm then compiles the data and sends it back to the participants.

Other employers look at compensation packages for certain positions on the Internet, from specialized websites such as salary.com or glassdoor.com. The information on these sites is less comprehensive than carrying out a targeted survey – they are also not as accurate because they are self-reported by the workers.

Compensation and benefits, commonly known as C&B, is a sub-discipline of human resources. It is known as remuneration or total rewards in most English-speaking countries.

Compensation benefits or basic rights?Most workers and every trade union would say that all the things listed in the above image are examples of basic workers’ rights. Some employers may see ‘paternity leave’ as an optional perk. All would agree that ‘meal breaks’ are not optional benefits.

Employee compensation & benefits components

An employee’s compensation and benefits are divided into four basic categories:

Guaranteed Pay: – this is the employee’s fixed income, his or her fixed monetary (cash) reward paid by the employer. Also known as the base or basic salary.

Variable Pay: this is a non-fixed cash reward paid to a worker that is contingent on performance, discretion, or results achieved. Examples include bonuses, commissions, and other incentives.

Benefits: these are programs the employer uses to supplement a worker’s compensation, such as a company car, medical insurance, paid time off, or a non-contributory pension scheme.

Some employers may also offer equity-based compensation, where the employee receives company shares as part of the pay package.

Compensation for damages and injuryIn the world of litigation, compensation refers to awarding (usually money) victims for injury, damage, illness, disability, loss of life, etc. resulting from the action or lack of action of an individual or company.

Compensation for damages or injury

Compensation may also refer to damages – awards usually in the form of money to be paid to a person for loss or injury. In common law, damages are categorized as punitive damages or compensatory (actual) damages. Compensatory damages are broken down into special damages, which may include loss of earnings, medical expenses and property damage, and general damages, which are non-economic such as emotional stress or pain and suffering.

Compensatory damages are awarded to compensate the claimant for injury, loss, or harm suffered as a result of another’s action or inaction, as may occur in a negligence claim under tort law.

When a party is suing for breach of contract, he or she is seeking expectation damages. The injured party’s interest in realizing the value of the expectancy that was created by the promise of the other party is protected by an award of expectation damages.

The aim of expectation damages is to put the non-breaching parties in a position they would have been in had they adhered fully to the terms of the contract. Expectation damages contrasts with restitution or reliance damages, which are types of compensation that address other kinds of interests of a party involved in enforceable promises.

Cary Grant compensation quoteCary Grant (1904-1986), a British-American actor, once said: “Do your job and demand your compensation – but in that order.” (Image: Wikipedia)

Factors determining the size of awards

Awards for damages, injury, loss of income, etc. can vary from fairly small sums to giant payouts worth several millions of dollars. The size of the awards are determined by a number of factors, including:

Claimant Age: this is important, especially when dealing with permanent injuries or fatal accident claims. Younger victims with a permanent injury have to live for longer with the PSLA (pain and suffering and loss of amenity). In cases where the victim died, awards are greater for younger casualties, especially if they have a partner and children.

The Injury: legal professionals will consider ‘like for like’ injuries with the case in hand and similar cases decided previously in the courts – we call these cases ‘precedents’. Typically, higher court decisions will bind those in the lower courts. So, in the UK and USA for example, judgments from the House of Lords or Supreme Court have greater authority than the lower courts.

A compensation award may only be right or wrong with reference to judgments that had occurred previously. In some cases it is a matter of opinion of how much may be claimed for an injury, and the skill of the lawyer in persuading the other party, and ultimately the judge that their case is right. In the vast majority of cases, the more severe the injury the greater the damages awarded.

Gender of claimant: in general, compensation awarded for damages for personal injury are the same for males and females. However, girls and women may receive more where the injury results in long-term damage or permanent scarring to the skin. Where scarring is clearly visible such as on the arms, legs or face, females will typically receive a larger amount in compensation than males.

Fortitude of the Claimant: if two claimants have the same age and suffered virtually identical injuries, it does not necessarily mean that they will be affected in the same way. No two humans are the same. Some individuals recover more quickly than others. Each claim is assessed on its own particular facts by the courts – if one claimant recovers faster or more slowly than another, the damages will reflect that.

Sometimes, the ‘psychological injuries’ that may follow an accident will increase the total award.

Special Damages: these are awarded when the plaintiff suffered quantifiable monetary losses, such as lost earnings (past and future), repair or replacement of damaged property, loss of irreplaceable items, additional domestic costs, etc. Compensation for special damages are seen in both personal and commercial cases.

Ben Bernanke compensation quoteBen Bernanke, an American economist at the Brookings Institution, who served as Chairman of the US Federal Reserve from 2006 to 2014, once said: “To be sure, faster growth in nominal labor compensation does not necessarily portend higher inflation.” (Image: brookings.edu)

Other meanings of compensation

Make up for: something that makes us feel better when we have an unpleasant experience, as in “One of the major disadvantages of working in the diplomatic service was never having a long-term, permanent home. However, there were compensations, like the chance to experience new cultures.”

In Psychology: a strategy whereby individuals cover up, either consciously or subconsciously, desires, frustrations, weaknesses, or feelings of incompetence or inadequacy in their lives through gratification or drive towards excellence in another area. Put simply: to emphasize a strength to make up for a weakness.

Video – What is executive compensation?

This Investors Trading Academy video explains in simple terms the definition of executive compensation.