Creating a compensation philosophy: everything you need to know

What is a compensation philosophy?

A company’s compensation philosophy is a written plan for how they reward employees and the values behind their approach. With the recent growing trend in pay transparency, many companies are rethinking how they approach employee pay. The first step in preparing for pay transparency is creating a compensation philosophy. Similar to a mission statement or a DEI statement, your comp philosophy should be a framework for individual pay decisions to establish a consistent and fair system. 

Here’s what you should keep in mind when writing one for your company.

What does compensation include?

When people hear the word compensation, they often focus on the base salary. But other forms of pay can play a large role in a package's total value. A CNN article found that a person’s total compensation can be 25%-40% higher than their gross salary.

Here’s a breakdown of the four main categories of compensation:

1. Base pay: usually an hourly or annual salary
2. Short-term incentives: individual and team level bonuses, commission
3. Long-term incentives: equity, stock plans
4. Benefits: insurance, paid leave, retirement, tuition assistance, other perks

A thought-out compensation philosophy considers each of these aspects. When it comes to deciding what incentives or benefits to emphasize, think about what makes the most sense for your company goals and employees. There’s no single best approach – it depends on what industry you’re in, what talent you’re recruiting, and the current market.

A good compensation philosophy… 1. Supports your talent strategy

Why are compensation philosophies so important? It’s because salary and benefits top the list of factors that people consider when choosing where they work. In other words, your compensation strategy is essential for your company’s ability to attract and retain talent. 

Aligning your talent strategy with your compensation strategy means thinking about what type of people you want to hire and what they’re looking for in their next job. If your talent team wants to source the best in the field, then the package you’re offering has to match that.

2. Is tailored to employee needs

People working in different industries and roles will value different benefits. For example, when it comes to hiring engineers, remote work is a top priority. In high-stress industries like healthcare hiring, promoting work-life balance and mental health resources can make your compensation philosophy stand out. 

One way to keep your compensation packages relevant and competitive is by keeping up with current hiring trends. Another more tailored approach is with employee surveys. These provide a look into what aspects of compensation your employees value the most.

3. Aligns with your company roadmap

Is success measured on a short-term or long-term basis? Are you rewarding individual or team performance? Questions like these, which depend on the specifics of your company, should determine how you structure your compensation philosophy. A strong rewards system is a great way of driving growth or performance for how it suits the company’s needs.

For example, if an early stage startup is prioritizing growth and short term performance, bonuses that celebrate hitting certain goals can boost morale, productivity, and overall company culture. On the other hand, a more established company can develop long term incentives. 

4. Has a compensation committee

All the points above show how compensation philosophies can get complicated. That’s why most companies have a dedicated compensation team. These compensation committees usually include input from C-suite executives, department leaders, and the finance team.

The executive team focuses on the big picture – how does the compensation philosophy align with the company’s mission and values? The department leaders provide more detailed insight into what’s needed in different areas of the company. And the finance team makes sure that the plan fits the budget.

Determining a compensation range with market data

Creating informed compensation ranges requires market data. Salary benchmarking tools are an easy way to access data that’s up-to-date and relevant. After researching the benchmarks, you have to decide on your market position.

There are three approaches to the market:

• Leading: pay ranges are above most competitors. This is more common in very competitive industries or hard-to-fill roles. The higher range is appealing for top candidates, but it can also lead to high performance expectations and revenue goals. 

• Matching: pay ranges hit the midpoint of competitors. This most common approach allows employers to still offer competitive wages while allocating some budget for benefits that differentiate the package. 

• Lagging: pay ranges are below most competitors. This is the least common strategy because it often makes attracting talent difficult. But companies can balance out their package by offering generous benefits like great health insurance or a 4-day workweek. Another example is a company that's limited to paying salaries between the 25th to 40th percentile, but offers significant equity options to attract candidates. 

Once again, the best choice is situation-dependent. Many companies also choose to do a mix of these approaches across different departments, depending on what their current focus is.

Next steps: communication and revision

After writing out your compensation philosophy, it’s time to communicate it to team members and future candidates. And like any good strategy, it should evolve with time and circumstance. You can read more about what these next steps look like in our preparing for pay transparency article. 

About Puck

We believe that leading with transparency is the path for finding the right people for your team. That’s why we built our salary range tool to help teams keep up with the labor market and make the right decisions. Stay up to date on hiring trends by staying in touch.