compensation policy

Creating a compensation philosophy and compensation policy document

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 small company could have a short compensation document (which would include the organization’s compensation philosophy and policies) that outlines:

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

As the business grows, it may be time to more 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 write a compensation policy document 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 policies. 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 similar to a company’s mission statement, but with a focus 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 goal of a compensation philosophy should be 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 measurable goals.

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

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 policies

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? 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 policies. Most of the time, there’s also a compensation committee working on the policies.

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 document 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.

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 (if applicable).

While not all organizations have a salary structure, those companies that do will be built 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.

6. 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.

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