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What is your company’s compensation philosophy? Did you know that you have one?

Every company has a compensation philosophy. Some are explicitly published by the company while others are implicit in the actions taken by various decision makers in the company. There are many who feel they have a philosophy but their employees do not agree. A 2017 survey by Payscale revealed that among their respondents, 31% of employers reported having a transparent compensation philosophy but only 23% of employees agreed

The advantages of a published compensation philosophy are obvious. Compensation actions can be viewed in light of the company’s stated compensation philosophy to ensure conformance. It not only is more difficult to ensure conformance to an unwritten compensation philosophy, but such a philosophy can change without notice and is subject to the capriciousness of the person making the compensation decision.

It is imperative to invest the time and energy to formulate a compensation philosophy that makes it clear what compensation plans are intended by the company and how they are to be developed, communicated, administered, and updated. The compensation philosophy is intended to guarantee that pay actions support and promote the company’s achievement of goals and objectives. Such an integration is hardly possible when compensation decisions are dictated by market forces alone. The philosophy should detail the company’s strategy, budget issues, short-term and long-term plans, and growth provisions.

Apart from building a solid understanding of how the company manages employee compensation, it also requires management to put teeth in its commitment to take full control of pay—including pay plan development, communication, administration, and ensuring all managers are trained in their role of compensating the company’s employees.

A compensation philosophy ensures every employee’s pay is administered in accordance with the predetermined, consistent direction set by the company. Development, maintenance, and analysis of pay ranges then become straightforward. In addition to HR’s expertise in these actions, all line managers must understand the company’s compensation philosophy so that they can make decisions in line with that philosophy—and explain to their employees how pay is determined. The education of managers and employees is central to the smooth, consistent, and orderly administration of employees’ pay, which in turn, is fundamental to the company achieving its goals and objectives for productivity, growth, and profitability.

Another benefit of a stated compensation philosophy is that it allows organizations to place themselves in the market according to the level of compensation they can afford. Organizations can become employer brands for superior talent by offering to pay fat pay checks and incentives for the same. Or they may choose to build talent by recruiting newcomers, investing in their training and development, and paying salaries that are just about the market range.

Stated compensation philosophies ensure stability and sustainability of the compensation strategy adopted by the organization. It has implications for the organizational strategy, as well as, all the other HR functions. If, for instance, compensation philosophy dictates paying market rates but training employees to ensure their retention, the learning and development function needs to be well-planned and developed to allow this. The resourcing function needs to choose internal recruitment options while performance management should reward employees handsomely for their performance.

An Example of Compensation Philosophy

Consider the following example of how a company stated its compensation philosophy.

XYZ Corp believes that our employees are our most significant resource, and our continued success depends on maximum use of their contributions. We strive to have compensation policies and practices demonstrate our appreciation for each employee’s contribution.

XYZ Corp’s compensation philosophy is to:

  • Reward employees based on their contribution to the company’s success.
  • Consider on-the-job performance as a primary factor when determining changes to an employee’s pay.
  • Provide employees with compensation opportunities that are competitive within the market.
  • Provide employees with compensation opportunities that are equitable within the company.
  • Ensure that all employees and management understand XYZ Corp’s policies, plans, and programs that govern compensation.

Purpose

When paired with an effective communication plan, the XYZ Corp compensation program supports, reinforces, and aligns with our mission and values, business strategy, and operational and financial requirements. Our compensation program balances the needs of both employees and the business, with a goal of growth and profitability.

The XYZ Corp compensation program is designed to attract, motivate, and retain talented employees who drive the company’s success. We strive to provide base salaries that are competitive and appropriate for the market. Each position is assigned a pay range as determined by XYZ Corp based on the position’s duties, responsibilities, and qualifications. The pay range is a reflection of what the market pays for the same or similar positions. The pay range minimum approximates the 20th percentile of the market while the pay range maximum approximates the 90th percentile of the market. The pay range midpoint is an average of the minimum and maximum.

Note: Deciding to use specific percentiles of the market to set the pay range minimums and maximums is a major step in the evolution of a company’s management philosophy. Not only does this decision require a solid understanding of how the company manages its employee compensation, it also requires management to plan all details of the compensation policy, be committed to it, and train its line managers to handle regular compensation issues. Whether to use the percentiles in the above example (20th and 90th) or any other should be a matter of enlightened discussion and definitive action by the company’s management team.

The Compensation Philosophy can be extremely potent given the sophistication of today’s pay surveys. It is not only possible but obligatory that a company’s compensation philosophy state the range minimum and maximum as explicitly defined points in the market. The midpoint then becomes just an average of the minimum and the maximum.

A compensation philosophy can and should be very specific about what to pay employees with the basic qualifications for each position, as well as, what to pay employees with outstanding qualifications. Telling your top performers that their pay opportunity is up to the 90th percentile, for example, can provide reason for such employees to invest a significant portion of their careers at your company.

Selecting a percentile at the lower end of the market data should be done with an understanding of the qualifications of employees whose pay is at the lower end. There is a point below which employees have less than minimum qualifications and minimum performance. It is possible to argue that that point is the 10th percentile or the 15th percentile or the 25th percentile. A company must arrive at this decision with the same level of sagacity as it used to determine the range maximums.

Determining Wages

Each employee’s position within the pay range is based on that employee’s skills, knowledge, and abilities as assessed by XYZ Corp, taking into consideration the employee’s education, training, experience, and performance. All employees must meet the minimum qualifications of the position. Those employees with less experience, less-developed skills, or whose performance does not exceed expectations will be paid in the lower portion of the pay range. Those employees with significant experience, fully developed skills, and whose performance meets or exceeds expectations will be paid in the middle portion of the pay range. Those employees with extensive experience, outstanding skills, and performance that exceeds expectations will be paid in the upper portion of the pay range.

Employees of XYZ Corp who are not meeting expectations are counseled to improve their performance before any pay increase is available. Employees counseled to improve their performance and who subsequently do not improve, will have their employment terminated.

In addition to base salary, XYZ Corp uses incentives or variable pay as a way to meet the strategic goals of the company. Incentive pay will be available to some employees with consideration for a number of factors and will be based on individual goals that relate to the company objectives as well as overall company performance.

Goals

In alignment with our company culture, we strive to communicate openly about the goals of the company and the design of the compensation program. The compensation process is intended to be fair and simple so that all employees and managers understand the goals and outcomes of the process.

The pay administration program at XYZ Corp was created to achieve consistent pay practices, comply with federal and state laws, and mirror our commitment to Equal Employment Opportunity. Pay decisions and reviews are made without regard to race, color, citizenship status, national origin, ancestry, gender, age, religion, creed, physical or mental disability, or any other factor protected by law.

Several factors may influence an employee’s rate of pay. XYZ Corp considers the essential duties and responsibilities of the job, market data, as well as individual and company performance. XYZ Corp periodically reviews its pay administration program and restructures it as necessary. Merit-based pay adjustments may be awarded in conjunction with superior employee performance as documented through the performance evaluation process.

Privacy

Pay, bonus, and any other type of compensation information are highly confidential. You should not discuss your compensation or other employees’ compensation with anyone other than your manager or Human Resources. You should bring any pay-related questions or concerns to the attention of your manager, who is responsible for the fair administration of departmental pay practices. Human Resources is also available to answer specific questions about the pay administration program.

Employees will not be paid below the pay range minimum unless there are issues related to the employee’s qualifications or performance. Employees will not be paid above the pay range maximum unless circumstances exist where an individual is required to fulfill specific needs of the company. Such needs may be a stated project or a specific goal to be realized in order for the company to achieve its goals and objectives. Paying below minimum (green circle) or above maximum (red circle) requires the approval of the VP of HR. Such approval will be based on the stated project or goal and upon a course of action to adjust the employee’s pay and/or classification following the achievement of the project or goal.

Managers are responsible for ensuring job descriptions are up to date for the positions that report to them directly or indirectly. HR reviews and approves the job descriptions and maintains copies for use in determining the market pay for the positions. Pay ranges are reviewed annually with respect to market pay and are adjusted to the appropriate levels for the upcoming year.

Individual employee performance is assessed through the Company’s Performance Management Program. Pay increase budgets are established based on market pay movement and the company’s finances. Based on the budgets and employees’ performance, pay increase recommendations are submitted to HR for review. Following its review, HR submits the recommendations to Management for review and approval. Approved pay increases are then communicated to employees by their manager in one-on-one meetings following the direction provided by HR.

This example shows how an organization can spell out the objectives, goals, and purpose of its compensation policy while also declaring the privacy and other ethical dilemmas that may arise in the future. By declaring all these aspects in detail, the company now not only possesses a clear direction, it is also more likely to formulate its resourcing and reward management decisions in the same vein. This will allow a well-integrated HR framework that can strategically support the organization.

Essential questions

When deliberating and deciding on a compensation philosophy, it is necessary to answer the following key questions:

  • Is the philosophy equitable, i.e., does it discriminate among employees on any non-work-related criteria?
  • Is the philosophy legally defensible and fair?
  • Is it possible to tweak the compensation policy based on labor market changes?
  • Is it possible to communicate the policy to employees and the general public?
  • Where does the firm’s philosophy stand when compared to its competitors?
  • What will be the compensation mix – fixed salary components vs variable? Performance based pay? Group incentives?

The answers to these questions will yield a well-drafted compensation policy that allows the organization to place itself in the desired market position as an employer, possess the right compensation mix, build a focus on rewards, and ensure differentiation among performers and non-performers.