Why does your organization pay the way it does? A clear compensation philosophy is key to writing fair, easy-to-understand compensation policies.

When it comes to compensation, it’s good to have a plan – ideally, before
you need it.

A philosophy that explains why your organization pays the way it does can
guide you as you write compensation policies. It can also help you ensure
alignment with equal pay laws and with your company’s vision and values around
pay equity.

Formalizing your compensation philosophy and policies gives your HR team
and managers guidance when they post jobs, make offers, negotiate with
candidates and give promotions.

Pay policies based on a written philosophy can also streamline budgeting for salaries, bonuses and raises, which is especially helpful during times of fast growth or in more challenging situations. And written compensation policies make it easier to follow legal requirements and internal guidelines for fair pay.

During a crisis or an economic downturn, having policies grounded in a
well-thought-out philosophy can help you manage salary cuts, furloughs and
related issues by providing a clear path to act quickly. That can allow you to focus
on keeping the business running, instead of having to build a survival plan
under stress.

When should your business write a compensation philosophy and policies?

Any company, regardless of size, can benefit from having something in place, even if it’s simple. For example, a company with five employees could have a one-page philosophy document that outlines:

  • Base pay
  • How it’s determined
  • Pay ranges for each role
  • Bonuses
  • Pay equity standards

Once your business reaches 10 to 20 employees, it’s time to formally document your pay philosophy and policies. Other sure signs that your company needs some structure:

  • High turnover related to low pay or a lack of raises
  • Negative feedback from current or past employees
    about pay discrepancies or inconsistent pay practices

How do you
make a compensation policy to support your growth, compliance and talent
retention?

First, it’s important to distinguish between a compensation philosophy and a compensation policy.

A compensation philosophy will guide the creation of your compensation policy. A written philosophy is also a commitment to your employees that you will follow through on your ideals.

Expect them to let you – and others – know if they feel your company
isn’t living up to the compensation standards you set.

Start with a compensation philosophy

The compensation philosophy is a broad statement, like a company mission statement but focused on pay. It should answer the question, “What are our goals on compensation, and why are these our goals?”

Because this document will be available to all employees, the
philosophy document doesn’t need to be than more a sentence or two. The goal is
to set the expectations, tone and broad parameters for your company’s pay
policies.

Even though your compensation philosophy should be general,
it should include a measurable goal.

For example, saying, “We want to be market-competitive and pay employees fairly,” doesn’t offer clear direction for writing a compensation policy.

It’s more helpful to say something like, “We’re going to use
market data or survey data to find competitive pay for our industry and assist
in setting our base pay.”

A compensation philosophy can also address your company’s
stance toward employee benefits, recognition and other topics. It’s also the
right place to spell out your organization’s commitment to equal pay for equal
work.

With a clear compensation philosophy in writing, you’re
ready to use it as the foundation for your pay policies.

Questions to ask before you write your compensation policy

Creating a philosophy is the first step to creating pay policies
that can help your company in good times and difficult ones. But there’s more
prep work you need to do before you can create effective compensation policies.

What compensation resources do you already have in place?

Even if you’re writing your organization’s first official
compensation policy document, you may not have to build it from the ground up.
Check for existing resources that can guide your policy – or which may need
updating as part of a policy overhaul. For example:

  • Do you have a
    salary structure     that outlines pay ranges at each level of your
    organization? If so, are the current structure and ranges market-based?
  • What are the details of your bonus plan? For
    example, is it a merit plan? What performance criteria is it tied to?
  • How are you making pay decisions? Are they
    clearly documented and understood by employees?
  • Is your pay structure fair and equitable now, or
    does it need adjustments to ensure that people doing the same kind of work,
    with the same amount of experience and responsibility, are compensated in the
    same way?

Who will help create your compensation policy document?

Typically, HR will be heavily involved in creating your
compensation policy. Most of the time, there’s also a compensation committee
working on the policy.

Putting together a committee to develop your compensation policy is ideal, because it brings a variety of viewpoints to the planning process. A committee will often include:

  • HR leaders
  • Executives
  • Managers from operations, sales and other teams

As you select your committee members, keep in mind that diverse groups
generate more innovative solutions than groups where all the members have
the same career paths, life experiences, backgrounds and educational
attainment.

Who’s the audience for your compensation policy document?

Your compensation policy is certainly an internal document. HR
and leadership get to see the document because they’ll be creating and using
it.

What about other employees?

That decision depends on your company’s level of
transparency. For example, some companies will only share their compensation
philosophy with their employees, while others will also share pay ranges and
other details of their compensation policies with their employees.

The level of compensation policy transparency you choose depends
on your organization’s preference. If you opt for transparency around
compensation, be mindful of the fact that your employees will be watching to
see if your company’s practices support your policy.

Even if you opt not to share your compensation policy
document with all employees, you could share your guidelines for ensuring equal
pay practices. For example, you could write into your policy that the HR
department will review the company’s pay structure every year, or every two
years, to ensure that your compensation practices, policy and philosophy all
align.

Once you have your compensation philosophy, committee members,
existing compensation resources and your audience, you’re ready to work on your
pay policies.

Tailor your compensation policies to your goals, industry and market

Focusing on the market midpoint pay range will work for many
companies’ pay policies. However, if your organization is based in a
competitive area (like Silicon Valley) or operates in a competitive industry,
your approach may need to be different.

So, if you’re in a fierce competition for top talent or
niche talent, you might create a policy that says you’re willing to pay a
premium, maybe the 75th percentile of market data.

Another item to include in your policies is bonus pay. As
with your base pay policy, it’s best to keep it general but include a goal.

For example, maybe your policy will say you’re going to offer a bonus plan to
all your employees, based on company and individual performance. Or maybe you
have a performance plan that’s focused solely on your sales teams. The details
will depend on the specifics of your business.

Build your compensation policy document step by step

Here are the typical steps for writing a compensation policy.

1. Start by stating your organization’s compensation philosophy.

This is the cornerstone for your compensation policies.

2. Include any necessary boilerplate.

Spell out your compliance goals and adherence to legal
requirements, particularly equal pay for equal work.

3. Focus on base pay first.

Explain how you’re setting your base pay parameters.

For example, if you’re using survey data, you might explain
the market rates and specific job titles you’re using to set your range.

You don’t have to go into detail about which surveys you’re
using, but it’s important to say which percentile or range you’re looking at. Then
you can put a dollar figure to that range.

If you’ve included equal pay for equal work in your
compensation philosophy, your base pay policy is the place to spell out how
you’ll implement it.

For example, you could create a policy that pay decisions
need to be documented and in line with objective criteria. You may also want to
require multiple levels of approval for individual employee pay increases that
fall outside a certain range, to ensure that those increases are applied fairly.

4. Spell out the salary structure for your entire organization.

This
will be based on the base pay range you’ve set, adapted to every level of the
company.

From
a transparency perspective, you don’t necessarily have to share these salary
ranges with everyone in your organization. It’s more common to just give
managers and the HR team access to that information. However, it’s certainly
possible to share your salary structure with every employee if radical
transparency is part of your culture.

5. Look at variable pay options.

Define
your bonus program if you have one. Consider creating one if you don’t. An effective bonus program
can:

  • Incentivize better performance
  • Reinforce positive aspects of your
    organization’s culture
  • Boost employee retention
  • Support organizational goals

With goals for your program in mind, think about the kind of
bonus programs that are most likely to appeal to your employees. These might
include bonuses for company, team or individual performance, and they might
come at year-end when certain goals are met.

Describe
the structure, criteria, dollar range and which employees are eligible. It’s
also wise to write
a feedback mechanism into your bonus policy to make sure it’s effective.

5. Other planning considerations

You can outline any premium pay, hazard pay or bonuses you’ll
provide to workers who put in extra hours or work under difficult conditions
during a crisis.

This planning step is also the place to outline your temporary layoff
plans and any wage reduction plans
you’ll enact during a recession or prolonged crisis.

Review your compensation policies regularly

It’s a good idea to review your compensation policies frequently, especially if you’re using market data to build your base pay policies.

It’s best practice to review market data at least every two years to make sure your survey-based base pay and salary structure still align with market conditions and your business objectives.

It’s also wise to review your compensation policy after a rapid market shift, because fast-changing conditions might mean your employees are suddenly underpaid relative to your competitors. If your organization uses market data, keep in mind that the survey data you use will take time to reflect these market shifts.

When your organization is growing fast, frequent reviews and
updates ensure that all the positions you’re adding are covered by the salary
structure.

Looking for more ways to reduce risk in your organization? Download our
complimentary e-book: HR compliance: Are
you putting your business at risk?

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