Compensation Philosophy: The “Why” Behind the Paystub

A compensation philosophy is an integral part of what makes a business tick. Communicating why and how employees will be paid for their labor grows in importance every day for anyone who manages pay for employees.

Expectations have changed, and competitive compensation has a vital role to play. The importance of pay transparency before the hiring process has grown, too. According to a 2022 Monster.com poll, 98% of workers say companies should put salary ranges in job postings and 53% say they would not apply for a job that doesn’t provide that information.

In the current climate, employers are particularly dependent on salary survey data to determine what kind of compensation package to offer job candidates. How should they give pay increases strategically to retain the current workforce and promote employee satisfaction? How can they provide better benefits that account for both physical and mental health?

All of those factors can be addressed by the overarching compensation philosophy.

What is a compensation philosophy?

Simply put, a compensation philosophy is a formal statement expressing the company’s stance and policies about employee compensation. It explains the “why” behind employee pay and creates a framework for consistency in the compensation structure. Employers use their compensation philosophy as a proverbial “North Star” to attract, retain, and motivate employees.

A good compensation philosophy supports the organization’s strategic plan and initiatives, business goals, competitive outlook, and operating objectives.

The company’s compensation philosophy is based on many factors, including its:

• Competitive market and financial data
• Size
• Industry
• Business objectives
• Market salary information
• Difficulty finding qualified talent

It’s important to note that the philosophy will help to anchor the organization’s culture, which is based on attitudes, opinions, levels of commitment, engagement, and satisfaction.

What are some compensation philosophy objectives?

A compensation philosophy aims to articulate a company’s compensation procedures clearly. When designing a philosophy, here are some common goals to consider:

Maintaining pay equity

Ensuring pay equity between colleagues for performing the same or similar work can make it easier to promote employee satisfaction. True, some natural payment differences may result from factors like seniority or a performance curve. But most successful philosophies create fair payment and reward structures, particularly within the same compensation peer group.

Furthering business objectives

An organization’s long-term goals are a crucial factor when defining compensation philosophies. For example, suppose a company aims to present a particular public image. In that case, the company might carefully construct its payment and rewards strategies to set an industry standard. Subsequently, it becomes easier for the organization to attract desirable candidates. Being publicly known as a company that cares for its employees well (with compensation) can be a wise and sustainable long-term business objective.

Staying in line with market trends

When designing a compensation philosophy, carefully look at competitiveness within the market. Research compensation trends, market data, and statistics. Attracting talented and qualified candidates can take time and careful planning. By offering comparable compensation strategies that are market competitive, you can craft attractive offers for new candidates. External pay equity also plays a role here as it helps employers gauge what they should offer to stay competitive.

Hiring

The difficulty of finding quality candidates can influence the goals of a company’s philosophy. If a position is tough to fill, the strategies need revision with the goal of attracting the right candidate. This could mean updating the philosophy, particularly for highly-specialized positions and executive talent. Transparency about pay can help attract top talent to a position and increase the chances of finding the right candidate.

Employee retention

Compensation philosophies are built to attract new candidates, but they should work toward retaining employees, too. Payment philosophies might outline incentives, ranges for different classes of jobs, and guidelines for raises or bonus payouts. These goals are set to engage and motivate employees and keep them satisfied with their compensation.

Balancing the budget

Most organizations are interested in minimizing operating costs. This includes the total compensation and wellness benefits they offer. The budget also must strike a balance. It must work to maintain employee satisfaction, stay competitive within the market, and support the company’s financial goals. From this, companies can build rewards programs and payment structures that align with multiple (and sometimes opposing) priorities.

A company’s size and financial status are also important factors in its ability to remain market competitive. Smaller companies may not have the budgets to support the compensation philosophies of larger rivals.

Legal compliance

Staying aware of relevant employment law policies and compliance can ensure companies are committed to fairness and equal pay. This is where HR professionals with knowledge and expertise regarding regulations (particularly the Equal Pay Act) can help companies. Make sure they’re involved in the process, particularly regarding compliance.

What to include in a compensation philosophy

Values

Some companies don’t represent their compensation philosophies with numbers alone. Many choose to incorporate an explanation of their company values and principles into their compensation philosophies. This lets others know what they hope to accomplish with their compensation packages.

Explanation of pay strategies

Compensation philosophies can explain how companies determine their pay. Some companies represent their compensation philosophy by identifying how much they’ll pay based on market standards. Typically, it’s communicated in percentiles. For example, the company might say they agree to pay in the 80th percentile of industry wages. They’ll pay their employees at least what the top 20% of professionals make in the same industry to remain competitive. But this isn’t the only compensation strategy out there. Others include equal pay, flexible pay, or tailored pay. You should also address the company’s approach to internal vs. external pay equity.

Compensation breakdown

Compensation breakdowns present the specific types of compensation employees can expect to receive. This may include base pay, benefits, and additional compensation or non-monetary rewards. Some companies establish fixed rates for specific positions or job classes and choose to share that information with employees. The job class defines the earning potential and compensation offered within a role. Others use methods based on seniority, merit, or performance. It’s all contingent on your company’s unique makeup.

Commitments

Commitments can also be helpful inclusions in your compensation philosophy. For example, a company might say it’s committed to offering an annual bonus at the end of each fiscal year. No matter what your commitments are, be sure to follow through.

Reviewing your compensation philosophy

Once you’ve developed a good compensation philosophy, it’s important that your strategic objectives truly follow through in practice. Ask these quality assurance questions periodically when you review your compensation philosophy:

• Is the philosophy (as it relates to the compensation program) equitable, defensible, legally compliant, perceived as fair, and fiscally sensitive?
• Can the organization effectively communicate the philosophy, policy, and programs to employees?
• How well do the offered programs align with the compensation philosophy and policies?

Set aside a time (at the very least once a year) to review questions like these. This will give you a chance to strengthen your philosophy, strategy, and policy. Work to better implement the company’s values through reflection and revision.

Build the right compensation philosophy for your business

Now that you have the complete picture of how companies build an effective compensation philosophy. Are you ready to move forward and develop your own? If you’re still looking for other helpful tips on HR and business management, check out Workest’s page. You’ll find everything you need — news, information, tools, resources, and more!