How Is Compensation Determined for an Employee?

Your Current Compensation Is Determined by These Factors

Image shows a woman at a desk with a laptop, coffee, and a stack of papers. Text reads: "How Do Companies Determine Compensation? Market research about the worth of similar jobs, employee contributions and accomplishments, availability of employees with like skills in the marketplace, desire to attract and retain a particular employee, company's profitability or funds available in a non-profit or public sector setting, previous salaries"

Image by Emilie Dunphy © The Balance 2019

Compensation is defined as the total amount of the monetary and non-monetary pay provided to an employee by an employer in return for work performed as required. Essentially, it's a combination of the value of your pay, vacation, bonuses, health insurance, and any other perk you may receive, such as free lunches, free events, and parking. These components are encompassed when you define compensation.

Companies base compensation on numerous factors. Some companies pay more attention to the following factors than others do but almost all companies use some form of analysis to set compensation. They want to fairly compensate employees to encourage positive morale, high motivation, and low turnover.

Market Research About the Worth of Similar Jobs

Numerous companies do formal salary surveys that can help companies determine the market rate of a job. In these salary surveys, companies report their current pay and benefits for jobs based on the job description.

The survey company then compiles the data and reports it back to the participants. These findings can be extremely accurate. They provide good insight into the competitive rates employers are paying in the marketplace for the employees performing the same or similar job duties.

Online Databases Help Employers Compare

There are also online database websites for salary information, where data is collected nationally and internationally. These sites such as and provide recommended salary ranges taking into consideration factors such as the job market, the location of the job, the size of the company offering the job, and the job duties and responsibilities. is recommended for its accuracy in the midwest. According to, "Compensation used to be a dark art. Not anymore. PayScale helps employers and their employees understand the right pay for every position and effectively communicate about compensation."

Other companies look at the data that is available on the internet, from websites like The data is not as accurate as that of a salary survey because they are self-reported by the employees. They are not comprehensive on all of the components of an employee compensation package either.

The job descriptions these salaries are based on are not as detailed as the ones in the salary surveys. Two people with wildly different responsibilities in two different companies may have identical titles, resulting in confusion as to what the appropriate compensation really should be for the employee.

It is also critical to consider local economies and company size. For instance, you will need to pay an administrative assistant to the CEO of a Fortune 100 company in New York City considerably more than the administrative assistant to the CEO of a company with 30 people in a small town in Iowa. Their job titles are identical—Administrative Assistant to the CEO—but their pay is completely different.

Employee Contributions and Accomplishments

You want your star employee to make more than your slacker employee, even if they have the same title. Companies recognize the difference in how much an employee contributes to the company through pay differentiation with merit increases going to their best. (But, ask yourself with some honesty, if you determine an employee is unworthy of a compensation increase, why are you employing this individual?)

The Availability of Employees With Like Skills in the Marketplace

When only one person in the town has a particular skill and two companies need that skill, the bidding wars can start. When only one company needs a particular skill and has two people to choose from who can both do it, they don't need to pay the employee as much money.

The organization with alternatives does not need to compensate the chosen employee with more than the going market rate.

The Desire to Attract and Retain a Particular Employee

If a company really wants a particular employee, then they'll pay more. If a company has a reputation as a horrible place to work, they may need to pay more to attract employees, for example. If the company has a terrific reputation and their employees are their best fans, they can pay less but know that market-rate pay keeps the best employees.

The Profitability of the Company or the Funds Available in a Non-Profit or Public Sector Setting

Often, non-profit or public sector businesses pay less. People are willing to work for them anyway because they believe in the mission and vision of the organization. The work of the organization may be consistent with their own personal values.

Or, in the case of government employment and unionized workplaces, the employees may value their job security and expected increases in an increasingly volatile world more than they value their ability to seek increased compensation.

Some public sector jobs have low paychecks, but high benefits, such as health insurance and pensions. With compensation, you need to look at the whole picture in both the public and the private sectors.

The Employee 's Previous Salaries

Basing a salary offer on an employee's previous salaries is a horrible way to determine a salary for a new employee. (And nationally, in a number of locations, it is now illegal because this practice is thought to perpetuate gender and racial disparities in compensation.) 

But many companies look at your salary from your last job and increase it by a small percentage. This can result in unfair compensation and discord within the company.

For example, when Bob was making $50,000 at company A and gets a 10% raise to come on board, he's probably happy with his $55,000. But, when he finds out that Jane, who has the same title and responsibilities, is making $66,000 a year because she was earning $60,000 at her previous company, he'll be understandably angry.

He may claim that the reason for the discrepancy is gender discrimination, and the company will be forced to prove otherwise.

Compensation also includes payments such as bonusesprofit sharing, overtime pay, recognition rewards and checks, and sales commission. Compensation can also include non-monetary perks such as a company-paid car, stock options in certain instances, company-paid housing, and other non-monetary, but taxable, income items.

Compensation is a fascinating topic, because, face it, people have various reasons for working, but the bottom line is that most employees work for money. It is in the best interests of an employee to try to receive more compensation. It is in the best interests of an employee to work their way up the corporate ladder to the executive level so that they can earn increasingly more money.

The Bottom Line

It's not in the best interests of an employer to have disgruntled, unhappy employees who feel they are underpaid. But, offering fair market compensation with generous benefits should help the employer make their wish come true—a thriving, contributing workforce in sync with the business aims and needs.

Article Sources

  1. "About Us." Accessed May 25, 2020.

  2. Society for Human Resource Management. "Salary History Bans Could Reshape Pay Negotiations." Accessed May 25, 2020.