Base Pay
The minimum salary paid to an employee
What is Base Pay?
Base pay is the minimum salary paid to an employee. It can also be interpreted as a fixed amount paid to an employee for a certain job. Base pay is only one component of an employee’s total compensation and does not include overtime pay, bonuses, benefits, or insurance. The rate can be stated as an hourly, weekly, monthly, or annual rate.
Base Pay vs. Total Gross Pay
Total pay refers to the total compensation of an employee, including all overtime pay, bonuses, benefits, insurance, etc., while base pay is the minimum fixed amount an employee will receive for a job. Apart from base pay, the other components of compensation tend to vary from year to year, as they are based on several factors, such as corporate earnings, division performance, individual employee evaluation, etc. It is especially true for bonuses and special benefits.
Total Gross Pay = Base Pay + Overtime Pay + Bonuses + Insurance + Benefits + Others
Example
Let us assume an employee gets a fixed annual salary of $50,000, a bonus of $25,000, and insurance and other benefits worth $10,000. In this case, the employee’s base pay is $50,000. It is the minimum fixed amount (before taxes) that the employee will receive as per his contract. Unlike bonuses and benefits, the amount will remain constant. However, the total gross pay of the employee, after factoring in the other items, is $85,000.
When faced with a choice of choosing a higher base pay and lower percentage bonus and benefits (variable pay) versus a lower base pay and higher percentage bonus and benefits (variable pay), it is important to looks at the expected values.
Let us assume two different compensation contracts. The first contract pays a base salary of $50,000 with no bonus and benefits, while the second contract pays a base of $30,000 with a 50% probability of receiving a bonus of $30,000. In this case, the expected values of contracts 1 and 2 are $50,000 and $45,000, respectively.
Even though the first contract does not pay any bonus, it yields a higher expected value than the second contract, as the bonus in the second contract is not guaranteed. However, if we increase the probability of receiving the bonus to 70%, we can see that the second contract yields an expected value of $51,000, which exceeds the expected value of contract 1.
Thus, it is important to think in terms of expected values, as well as consider your personal level of risk aversion when comparing contracts that pay fixed amounts with contracts that include a variable component.
Factors Affecting Base Pay
1. Level of education and skillset
Base rates and salaries vary drastically depending on the industry and market situation at any given point. Careers/professions that require specialized knowledge and skillsets generally offer higher base salaries than those that are offered to administrative and manual labor roles. Similarly, benefits and bonuses also tend to be higher for careers that require higher levels of education.
2. Location and supply and demand in the labor market
The location and supply and demand dynamics of the labor market are two key determinants of base pay. Locations with high costs of living and high inflation tend to report higher base salaries than locations with lower costs of living and lower inflation.
The labor market condition for a given profession at any given time can also exert a significant impact on the base pay of that industry. Professions that require specialized skills generally face a low labor market supply and thus higher base pay rates. On the contrary, professions that do not require any specialized skills are characterized by low barriers to entry and a high labor market supply, leading to lower base rates.
3. Applicant’s personal profile
In addition to market conditions, the personal profile characteristics of the candidate are also key determinants of base pay. They include years of experience, education, skillset, performance reviews, referrals, etc.
Years of education and work experience tend to be positively correlated with base pay. Similarly, a candidate with good past performance evaluations and referrals is likely to attract a higher base salary than a candidate with poor evaluations.
More Resources
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To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:
