Until a few years ago, the terms “compensation” and “compensation and benefits” were used commonly. But more recently, these terms have been replaced with “rewards” and “total rewards.” A reward system is the set of mechanisms for distributing both tangible and intangible returns as part of an employment relationship.

An employee’s tangible returns include cash compensation (i.e., base pay, cost-of-living and merit pay, short- and long-term incentives) and benefits (i.e., income protection, tuition reimbursement). In addition, employees also receive intangible or relational returns, which include recognition and status, employment security, challenging work, and learning opportunities. Not all types of returns are directly related to performance management systems. Some returns are based on seniority, as opposed to performance.

Base pay is given to employees in exchange for work performed. The base pay, which usually includes a range of values, focuses on the position and duties performed, rather than an individual’s contribution. Base pay is usually the same for all employees performing similar duties. Cost-of-living adjustments (CoLa) provide the same percentage increase for all employees, regardless of their individual performance. CoLa are given to combat the effects of inflation to preserve the employees’ buying power.

Short-term incentives, sometimes called variable pay, are one-time payments allocated based on past performance. Incentives are not added to the base pay and are only temporary pay adjustments based on the review period. Conversely, long-term incentives attempt to influence future performance over a longer period of time. Typically, they involve stock ownership or options to buy stocks at a preestablished price. This investment is expected to translate into a sustained high level of performance.