How to Define Your Compensation Philosophy

May 31, 2022
November 7, 2023
Sarah Lindenfeld Hall
Lattice Team

For decades, companies have kept employee compensation packages shrouded in mystery. Just a dozen years ago, 66% of private employers actively discouraged salary discussions or formally prohibited them, even punishing employees for talking about pay and benefits, according to a 2010 study from the Institute for Women’s Policy Research (IWPR). But amid the COVID-19 pandemic and the Great Resignation it helped trigger, a lot has changed in the work world since then — including the expectations of the people working in it.

Pay is just part of the overall package that’s luring talent to jobs now, along with flexible working hours, remote work, more time off, and more rewarding work, according to a 2022 Bankrate Job Seeker Survey. And younger workers are more likely to talk about their earnings — about 40% of Generation Z and Millennials compared to 31% of GenXers and 19% of Baby Boomers, according to the Bankrate survey.

That, along with new pay transparency laws that are emerging across the country, is prompting employers to take a hard look at how their employees are compensated through pay and benefits — and to define or redefine their compensation philosophies.

Like a company mission or values statement, “a compensation philosophy is just another one of those pillars that goes into helping set and manage expectations,” said Jessica Lambrecht, founder and CEO of The Rise Journey, a Human Resources strategy and organizational culture consulting firm. “And having clarity on how they are compensated and how they can affect their own compensation…so they feel they have control over their careers…is really important to people.” 

Here’s what employers and Human Resources professionals should know as they set out to define their organization's compensation philosophy.

What Is a Compensation Philosophy? 

A compensation philosophy outlines the guiding principles that cover how an organization pays and rewards its employees. It’s “your strategic blueprint for making compensation decisions,” said Elliot Dinkin, President and CEO of consulting and actuarial firm Cowden Associates. “We have a strategic plan for our company, and we have an operating plan, and we need one…for compensation and benefits.”

When formally done, a compensation philosophy is written out as a mission statement or handbook, according to Lattice’s latest eBook, HR’s Guide to Setting a Compensation Strategy. It typically covers “total rewards” — base pay, along with bonuses, health insurance, paid time off (PTO), sick leave, flexible working hours, and retirement plans, among other perks.

And, just like a corporate culture, organizations likely have a compensation philosophy whether they were deliberate in creating one or not. Companies may be operating under an old or unwritten philosophy around how they’re compensating their employees that’s built solely on historical pay practices. That could be maintaining longtime problems of pay inequity and unfairness that can lead to employee disengagement, turnover, and legal claims.

“Whatever you’re doing is becoming the culture, the norm, [and] the philosophy,” said Ashley Cox, founder and CEO of Human Resources consulting firm SproutHR. “Even if you’re just continuing to do what you’ve done, you’re perpetuating whatever philosophy was either adopted intentionally or unintentionally in the past.” 

Why Do Compensation Philosophies Matter? 

With pay practices and salary levels secret for so long, bad habits and discriminatory practices have festered. Women have yet to achieve equal pay; they still earn 83% of what men take home, according to the American Association of University Women (AAUW). And a study found that white men get the raises they asked for far more than people of color. 

An intentional pay philosophy levels the playing field for managers and employees. It brings together everybody in the organization, along with their ingrained biases and personality quirks, to ensure they’re operating under the same expectations, Cox said. 

“That’s the key about having a strong, well-spelled-out, well-communicated philosophy with your team [that states]: This is what we believe when it comes to pay and compensation. And this is how we implement that,” she said.

How to Start Defining Your Compensation Philosophy

It all starts with your company values. “You have to look at what your company’s mission, vision, and values [are],” said Jodi Brandstetter, founder and Chief Talent Strategist of Lean Effective Talent Strategies (LETS), a hiring and recruitment consultancy. “And make sure you tie that compensation philosophy [to] those values.” 

If your compensation philosophy isn’t aligned to your mission or values, nobody is going to buy it, Cox said. An organization that values and builds its culture around innovation could have a very different compensation philosophy than one that values health and wellness, and each needs to be sure to tangibly connect their compensation philosophy to their company’s culture and values. 

For example, the company that values innovation might design its pay practices around opportunities to reward people for their work to develop new products or ideas. “That might look like having various types of stipends, trips, [or] ways for people to just show up in the workplace [as] their [top-performing] selves and be rewarded for that,” Cox said.

On the other hand, the company that prioritizes health and wellness may be more focused on offering gym memberships, onsite yoga classes, mental health days, or unlimited paid time off, she continued. 

From there, organizations must consider an array of other factors related to hiring and retention when crafting or updating their compensation philosophy. These include:  

  • Business Objectives: If your business strategy requires you to hire world-class engineers to develop cutting-edge software, for example, your pay philosophy and compensation program will need to match that, Dinkin said. You’ll need to offer competitive compensation and perks to lure top talent to your organization.
  • Competing Employers: When considering market salary data, don’t just compare the rates in your industry; you want to consider how much companies that are competing for the employees you want are paying. If you’re hiring people to work in a call center, for example, you may be competing with other call centers for workers — but also with local grocery stores, too, said Brandstetter. 
  • Hard-to-Fill Jobs: If you’re having trouble attracting and retaining talent for specific roles because of competition for labor or low wages, your compensation philosophy could spell out at what point special considerations should be made for jobs that are particularly hard to fill, Dinkin said. For example, roles that remain open for longer than two months might be considered “hard-to-fill,” triggering incentives, such as a one-time cash bonus or an increase in the hourly rate, to help fill them.  

What Should Comp Philosophies Include? 

Next, HR leaders need to get into the specifics of how their employees are compensated, as the new Lattice eBook explains. Here are three examples of the kinds of details that compensation philosophies often include.

  • Total Compensation: Employees typically don’t just earn a base salary — organizations attract new hires and retain talent with a package of benefits that includes everything from health insurance and vacation time to student loan repayment. A compensation philosophy usually includes the total package. But as HR teams consider the total rewards they’ll extend, it’s important to ask their employees what they actually want. 

    “Too many times, we think [that] as business leaders [and] HR professionals, we have all the answers. And a lot of times we get it wrong when we make too many assumptions,” Cox cautioned. “Especially in a diverse workforce…it’s really important to pause and ask.” 
  • Salary Structure: Salary range is a compensation metric that provides the minimum and maximum range that an organization will pay people in the same job level. For employers, pay bands can help clear up misconceptions about how employees with the same role are paid and help ensure raises are doled out fairly, the eBook explains. The level of transparency will depend on the business and is part of its pay philosophy, too. 

    “You can share the base minimum of the different bands, [and] where you can go,” said Cox. “You can have that conversation during performance reviews. You can choose when and where to share and how deep you want to go.” 
  • Raise Models: An organization’s compensation philosophy also maps out how employees can earn more in pay and benefits going forward. There are a variety of options, including profit-related pay formulas where employees are compensated based on the success of the overall business.

    But performance-based raises and bonuses may be the best option, cultivating greater job satisfaction, organizational commitment, and trust in management, according to a study published in Human Resource Management Journal. In this model, employees earn more money as they hit specific targets and expectations. 

Compensation philosophies map out these and other practices for rewarding employees, giving them a clear vision into how pay and benefits are distributed and how they can earn more.

Communication is essential, especially with a topic as emotionally charged as compensation,” Cox said. “When we hide things or don’t share [information], that’s when people make assumptions, accurate or inaccurate. That’s when people start to feel like the company is hiding things on purpose, which is never a good thing.” 

Not a ‘Cure-All’

A compensation structure and philosophy can bring transparency to pay practices. And when organizations do the work to be more forthright in their compensation decisions, they can ensure that all employees, regardless of who they are or what roles they occupy, are paid fairly and equitably. 

But a compensation philosophy isn’t a cure-all. Employers must still be on guard for unconscious bias that can seep into compensation decisions, cautioned Matthew D. Besser, an employment discrimination attorney at Cleveland-based law firm Bolek Besser Glesius.

Companies should always be on the lookout for opportunity gaps, advised Besser. Consider a sales team where individuals must secure a specific number of new clients to reach the highest level of a pay band. But if women on the sales team aren’t invited to socialize at the golf club with their male coworkers and senior managers who are networking with potential clients there, they may not have the same access to high-quality leads. “The band is great if everybody in the band is fairly there,” Besser said. 

Using performance ratings to determine raises for employees works well — if nobody is bringing their unconscious bias to the conversation, noted Besser. If performance-based ratings are used, he advised including as many objective criteria as possible, and bringing in multiple individuals beyond the employee’s direct supervisor (as would happen in a 360-degree review) to rate their performance. 

Regular pay audits — deep dives into the actual compensation that employees are receiving — can also reveal discrepancies that need to be resolved. “Have a neutral, outside person come in and take a look at the data, and then examine [if there] are outliers across groups or outliers for a particular manager and a particular employee,” Besser said.

How Often Should You Revisit Your Compensation Philosophy? 

Just like pay audits, a compensation philosophy is something that organizations need to revisit regularly, Cox said. She recommends reviewing them at least annually. Major shifts in your organization — such as expanding into a new region or adding a new product line — might prompt a quicker look. High rates of turnover or a pay audit that uncovers issues could signal the need to revisit it more frequently to determine practices that need to be shored up. 

“This is not like a Crockpot — there is no ‘set it and forget it,’” said Cox. “Everybody at every level needs to understand what’s relevant and important about your compensation philosophy and how it applies to your organization and aligns with your [company] values.”

Ready to get your compensation philosophy and practices on track? Download our latest eBook and learn more here about our new compensation solution launching soon.