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Compensation Philosophy: What It Is and Why Every Organization Needs It

by Tim AustinDecember 17, 2018 1:18 PM

Ever wonder the reasoning behind a paycheck? As in, why does one employee make a certain amount, while another earns more or less? It all comes down to an organization’s compensation philosophy. 

Does your organization have a compensation philosophy? A WorldatWork survey found that more than nine in 10 companies have a compensation philosophy; however, that doesn’t mean their compensation philosophies are any good. Nearly one in three compensation philosophies aren’t in writing, while about half of employees don’t even know or understand them. This presents a huge missed opportunity for companies, as there are many benefits to pay transparency. 

Intrigued? Read on to learn what compensation philosophy is and how your organization can benefit from having a good compensation strategy in place.

 A small business owner handing out a paycheck that was based in compensation philosophy.

What is Compensation Philosophy?

A compensation philosophy answers the “why” behind employee pay. In a formal, written statement, a compensation philosophy should identify the organization’s pay programs and reward strategies and create a framework for consistency. This basis will serve as the guiding principles that drive decision making regarding compensation at a company.

Compensation philosophies are typically created by your company’s human resource professionals. That may be a dedicated employee or yourself, depending on the makeup of your business. When developing a compensation philosophy, the Society for Human Resource Management (SHRM) says several factors should be taken into consideration, including:

  • Company’s financial position
  • Size of the organization
  • Industry
  • Business objectives
  • Market salary data
  • Level of difficulty finding qualified talent

A good compensation philosophy should support the organization’s business goals and objectives, while still being competitive in the market. A reward system for raises and bonuses should also be factored into a compensation philosophy.

Why is Compensation Philosophy Necessary?

Compensation philosophies are used to attract, retain, and motivate employees. There are several reasons why your organization should be transparent about your compensation philosophy.

Demonstrate commitment

By taking the time to ensure fair compensation strategies, your organization can help employees feel appreciated. According to a survey by the American Psychological Association, 93 percent of employees said they are motivated to do their best work when they feel valued. Sharing your compensation philosophy will show your employees that you care and are invested in their wellbeing.

Retain employees

The way you approach compensation can have a direct impact on employee satisfaction. In fact, how they feel about your pay process can be even more important than how much they’re paid. According to a PayScale survey, an employee’s perception of your payroll process is “5.4 times more impactful on how satisfied they are than how they’re paid relative to market.” That suggests that if your organization is fair and transparent about compensation, employee satisfaction and retention rates could increase.

Attract talent

Payroll transparency can impact more than just your current employees. Publishing or sharing your compensation philosophy with job candidates should attract more talent and help find the right people whose needs and values align with your philosophy. As SMART Recruit Online found, job listings with a compensation listed increased the total number of candidates by 30 percent. Candidates appreciate companies that are transparent about pay, and the number of applicants an organization receives will likely reflect that.

Ensure equal pay

While there are allowable pay differences based on factors not prohibited by law, your compensation philosophy should show equal pay for equal work. Feeling underpaid is a top reason why employees quit their jobs, so ensuring equal pay through your compensation philosophy will help increase retention rate.

How to Write a Compensation Philosophy

There are many different types of compensation philosophy. For example, financial services company Citi and predictive marketing platform Windsor Circle are two very different, yet good compensation philosophy examples. Citi takes a more philosophical approach to its compensation philosophy by laying out guidelines rather than fixed numbers, whereas Windsor Circle delves into the details of its compensation package. Despite their different approaches, both compensation philosophies hit the marks on fairness, transparency, and commitment.

The Houston Chronicle laid out four different ways you can write a compensation philosophy.

Percentile-based

Some organizations will use percentiles in their compensation philosophy. Percentiles spell out where wages will fall in relation to the regional wage market. For example, a company might pay its employees at the 60th percentile of the regional wage market. This means that employees will earn more than the bottom 60 percent of your market, but less than the top 40 percent of that same population.

Fixed numbers

A compensation philosophy that uses specific numbers will detail exactly what each employee makes. For example, an entry-level employee might make $25,000 during their first year, and $30,000 during their second year, dependent upon good performance. Listing a fixed number or range can also help attract more candidates when it comes time to hire.

Compensation package breakdown

A compensation structure is a great place to include items apart from salary that make up an employee’s compensation package. This will include base pay, health insurance, and other forms of indirect compensation and even non-monetary rewards like recognition and achievements.

Non-specific

A non-specific compensation philosophy won’t provide percentiles, hard numbers, or even a breakdown of what the compensation package includes. Instead, the compensation philosophy will focus more on the guiding principles that help the organization determine how it will pay its employees. The philosophy, using Citi as an example, might say that one of its objectives is to “attract and retain the best talent to lead the company to success.” Citi’s philosophy aims to do this by providing competitive compensation programs and compensating employees based on ability, contributions, and performance.

How to Review Your Compensation Philosophy

Compensation philosophies should be reviewed regularly and updated when necessary. When reviewing your compensation philosophy, SHRM says you want to be able to answer “yes” to the following questions.

Is the compensation philosophy equitable? 

HR is the neutral department in an organization, so it’s your duty to make sure all rules, including employee pay, are fair and impartial. One department or employee shouldn’t get preferential treatment over another unless there is a justifiable reason behind it.

Is the compensation philosophy defensible and perceived by employees as fair?

There will be times when you need to defend your compensation philosophy like when an employee asks for a raise you can’t give. A good compensation strategy will retain talent by motivating employees to perform to their full potential and rewarding those that do. It will also attract candidates with the right salary requirements. Make sure wages are competitive with market value, or an employee or potential candidate may seek an opportunity that pays better elsewhere.

Is the compensation philosophy fiscally sensitive?

It’s important to define the competitive market position of the organization as it applies to base pay, variable compensation, and benefits opportunities. Make sure the compensation strategy supports the business strategy, competitive outlook, operating objectives, and human capital needs.

Are the programs included in the compensation philosophy legally compliant?

The rights of employees to be free from compensation discrimination is protected under several federal laws, including the Equal Pay Act, Title VII, the Age Discrimination in Employment Act (ADEA), and the Americans with Disabilities of Act (ADA). The Fair Labor Standards Act (FLSA) also dictates minimum wage, overtime pay, recordkeeping, and child labor practices.

Does the organization effectively communicate the compensation philosophy to employees?

Communicating the compensation philosophy to employees can create a sense of fairness so no one feels cheated or underpaid. The WorldatWork survey found that 46 percent of organizations share minimal pay information with their employees, and the ones that do say more than half of their employees don’t understand it. When you share your compensation philosophy with your employees, opt for an “open door” policy so employees feel comfortable asking questions.

Does the compensation strategy attract new hires?

It’s a good idea to make job candidates aware of a company’s compensation philosophy, as it can help attract top talent. Does your compensation philosophy include salary listings, fair market pay, and language that makes employees feel valued? Applying these strategies can help attract more new hires to your business. 

Attract and Retain Good Employees with the Right Compensation Philosophy

Simply having a compensation philosophy isn’t enough. Understanding what makes a good compensation philosophy and being transparent about pay will help your organization attract, retain, and motivate employees. 

Group Management Services offers a variety of payroll, risk management and human resources services, including national and local compensation strategies for businesses looking to hire. Contact GMS today to talk with one of our experts about how you can define compensation philosophy at your organization.

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