Components of an Effective Compensation Plan


Compensation is a fundamental component of the employment relationship and combines the extrinsic and intrinsic rewards received by employees for performing their jobs. It encompasses all the intrinsic and extrinsic payments made by a company to individuals for services rendered. However, despite their integral role in such aspects as performance and sustainable competitiveness, organizations experience challenges in formulating effective compensation plans. Consequently, companies engage remuneration professionals who work with senior-level management to develop comprehensive internal and market consistent payment strategies, which will enhance employee recruitment, job performance, and retention.

Notably, an effective program integrates intrinsic and extrinsic rewards in a way that articulates and advances the competitive strategic objectives of the firm. For instance, a well-designed plan should be sensitive to internal and market consistency and incorporate such components as merit, to reinforce the essence of excellent performance and such incentives as commissions and benefits. Although compensation constitutes the single greatest operating cost for many businesses, organizations should formulate their payment programs in an internally and market-consistent manner that promotes the attainment of the firm’s competitive strategic objectives.

The Importance and Elements of an Effective Compensation Plan

Compensation refers to all the intrinsic and extrinsic payments organizations offer to their employees for performing their duties. Organizational development professionals and compensation experts design effective employee remuneration systems by integrating monetary, nonmonetary, and psychological rewards that accrue from the performance of a job. According to Martocchio, compensation is a fundamental organizational consideration increasingly deployed strategically to enhance competitiveness and performance (1). Kang and Lee corroborate this perspective and assert that human resource practitioners recognize the indispensability of aligning the compensation systems with the overarching organizational goals (2). In this regard, employee remuneration plans are fundamental and directly contribute to attaining the company objectives.

An effective compensation plan is a foundation against which employee recruitment, retention, and job performance are anchored. However, for a remuneration program to achieve those ideals, it should incorporate various vital components, which cumulatively articulate the competitive strategic goals of the company. Additionally, Leitao et al. argues that it serves as an internal and external communication reinforcing such aspects as the firm’s philosophy, the expectation of employees, and the direction of workers’ behavior (3).

According to Martocchio, an effective compensation program should be internally and market-consistent, have competitive reference points, articulate performance metrics, communicate its relative importance, and align to the overarching organizational positioning (1). For instance, the design of the reward system should reflect such company needs as a requirement for top performance while recognizing the position of the business in a given industry.

Beneficial Ratio of Internally and Market-Consistent Compensation System

Compensation professionals and organizational development expertise should collaborate to develop an effective remuneration program that is internally and market-consistent. Choudhary asserts that these two components are the primary goals that remuneration experts seek to achieve (4). In most organizations, the most beneficial combination of internal and market consistency of compensation programs is achieved at the ratio of 1:1. Acording to Martocchio, firms should aspire to balance between internal and market consistency to reflect the uniqueness or similarity of jobs within the company while promoting the enterprise’s ability to attract and retain qualified personnel (1).

Lazear argues that a business can adopt the lead-the-market compensation strategy where employees are paid more than the industry and competitors’ average to improve the firm’s recruitment attraction and retention levels (5). Similarly, organizations should consider a job’s qualification requirements, complexity, and degree of responsibility to structure their reward plans. For instance, staff in a complex engagement with greater responsibilities and demanding higher competencies should earn more than their counterparts whose jobs entail lesser qualifications.

Organizations that disregard internal consistency and implement exclusive market-oriented compensation plans may experience such challenges as inflated payroll costs, leading to the loss of the firm’s competitive edge. Conversely, companies that adopt strict internal consistency may lose their ability to attract, recruit, and retain talented and highly qualified employees. From this perspective, it is prudent for organizations to structure internal and market consistency on a ratio of 1:1.

Methods Companies Use to Assess Employee Satisfaction with Pay Structure

Organizations generally use Employee Net Promoter Scores (eNEP) and the traditional anonymous staff satisfaction surveys to measure the personnel compensation gratification levels. The former is a scoring system designed to extract valuable insights that help employers gauge employee satisfaction on various subjects. Yaneva posits that eNEP generates responses that highlight the employees’ overall perception of the company (6). Notably, business executives can extrapolate the measurement results to determine the extent to which the personnel is satisfied, engaged, loyal, and even predict their retention potential.

Similarly, organizations can structure and conduct anonymized surveys, which ask specific questions on employees’ level of satisfaction with the pay structure. Organizations can enhance the value of the data by comparing the insights with those obtained from another firm within the same industry. However, this approach requires extensive preparation and the formulation of questions that provide valuable and actionable data. For instance, the survey can focus on such topics as the extent to which compensation is commensurate to performance and suggestions for possible improvements or addition of benefits.

Determination of the Competitiveness of Employer-Sponsored Retirement Plans and Health Insurance Programs

Compensation professionals are continuously evaluating the competitiveness of the organization’s employer-sponsored plans and health insurance programs. Martocchio contends that it is imperative for a company to understand the remuneration and reward patterns and benefit differentials prevailing in the wider context for such decisions as alignment to the firm’s strategic objectives (1). Martocchio argues that companies determine the competitiveness of the employer-sponsored retirement plans health insurance benefits by assessing the interindustry trends, employment, labor relations provisions, occupational and geographical differentials (1).

For instance, since organizations operate within a global context, compensation professionals can evaluate such specific components as nature, provisions, comprehensiveness, and limitations of a health insurance benefit of a business within the same industry. Similarly, compensation analysts can conduct comparative assessments of retirement and health benefit programs offered by other organizations employees within the same occupation. To achieve competitiveness, a company should ensure that its benefit plans surpass those provided by enterprises within the same industry, geographical locality, and for the same cadre of employees.

Recommendation of High-Value Discretionary Benefits for Employees

Organizations offer a wide array of discretionary benefits to build and sustain positive relationships with their workers and enhance their attractiveness to potential high qualified employees. These reward plans are designed to improve employee packages and protect them from some unforeseen and potentially adversarial occurrences (Klonoski, 7; Nemeckova, 8). From this perspective, the two high-value discretionary benefits for employees are retirement and disability and life insurance.

The rationale for recommending retirement is the financial security it offers individuals once they are old and can longer engage in gainful employment. Ketkaew et al. posit that the guaranteed monthly income helps retirees maintain decent living standards and promotes their overall wellbeing in retirement through the regular inflow of earnings (9). Therefore, retirement is a high-value discretionary benefit for all employees.

Additionally, disability and life insurance rank prominently among the high-value discretionary benefits. The rationale for suggesting their considering and inclusion in the compensation package is that employees want financial protection and security for their families in the event of tragic occurrences. Notably, this option provides a wide range of benefits to support an employee during incidences of short- or long-term disabilities and injuries. This implies that a worker who dies or incurs any form of incapacitation and can no longer work gets income replacement for themselves or their families from the disability package. In this regard, disability and life insurance discretionary benefits are of significantly high value to employees.


Organizations are increasingly recognizing the essence of designing their compensation programs in a way that contributes directly to the attainment of the companies’ strategic objectives. Human resource practitioners understand the role of an effective reward policy and its impact on successful business outcomes, particularly regarding the plan’s potential of attracting, motivating, and retaining highly competent employees.

Consequently, internally and market consistent compensation packages are emerging as indispensable components of a firm’s reward programs, which are most beneficial when combined on a ratio of 1:1. Additionally, businesses are employing eNEPS and conventional survey methods to assess personnel’s satisfaction levels with their pay structure and utilize inter-industry, regional, and occupation to determine the competitiveness of their retirement and health insurance schemes.


  1. Joseph J. Martocchio. 2020. Strategic compensation. Web.
  2. Eungoo Kang and Hyoyoung Lee. 2021. Employee compensation strategy as sustainable sompetitive advantage for HR education practitioners. p. 1-23. Web.
  3. Francisco Junior da Silva Leitao, Joao Paulo Correa Da Silva, and Cristina Lourenco Ubeda. 2016. Strategic compensation as a factor of attraction for students graduating in business administration: A Brazilian case. p. 162−175. Web.
  4. Supriya Choudhary. 2016. Job evaluation: A strategy for compensation consistency. p. 90-100. Web.
  5. Edward P. Lazear. 2018. Compensation and Incentives in the Workplace. p. 195−214. Web.
  6. Maya Yaneva. 2018. Employee eatisfaction vs. employee engagement vs. employee NPS. p. 221−227. Web.
  7. Robert Klonoski. 2016. Defining employee benefits: A managerial perspective. p. 53−72. Web.
  8. Iveta Nemeckova. 2017. The role of benefits in employee motivation and retention in the financial sector of the Czech Republic. p. 694−704. Web.
  9. Chavis Ketkaew, Martine Van Wouwe, Preecha Vichitthamaros, and Duanpen Teerawanviwat. 2019. The effect of expected income on wealth accumulation and retirement contribution of Thai wageworkers. p. 1−20. Web.
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