Compensation used to mean a fixed salary with annual increases. This model rested upon employee demands to be paid based on the number of hours worked and years of service. Today's compensation needs to reflect the “new” contract between employers and employees – where performance is rewarded regardless of effort or tenure.
Pay-for-Performance ("PFP") systems tie compensation directly to specific business goals and management objectives. To do this, companies must deliver competitive pay for competitive levels of performance, pay above market for exceptional performance, and reduced pay for poor performance. To achieve this, companies must match measurable and controllable performance targets to company objectives.
In PFP systems, employees’ compensation is composed of a fixed base salary and a variable component. The most commonly used variable components are:
- Company equity (Phantom or actual) - the quantity and price to be paid are typically based on a percentage of value added as determined by the performance measurement system;
- Bonuses - cash awards for extraordinary accomplishments or other activity-related distributions;