In theory, a compensation philosophy is a formal written statement that reveals the company's stance on employee pay and rewards. Compensation philosophies vary from company to company.
However, they often involve addressing the "what," "why," "how," "how much" and "how often" of employee rewards in a manner that aligns with the company's mission, vision and strategic objectives. Ultimately, the result is a synchronized set of practices and policies that guide decision-making when it comes to creating and distributing compensation.
In practice, a compensation philosophy is more than a formal document. It is also a product of the company's culture, as the structure of the philosophy is indicative of how employees can expect to be treated in terms of rewards.
Without a compensation philosophy or policy, the organization has no frame of reference for rewarding its employees, resulting in an ad hoc approach, where there's no consistency or theoretical or practical basis from which to work.
Conversely, a well-designed philosophy focuses on attracting, retaining and motivating employees through base pay and salary structures, cash or noncash incentive pay such as bonuses and stocks, and benefits such as health insurance and retirement savings. Though consistency is imperative, the philosophy also needs some level of flexibility in order to reflect changing market conditions and the business's position at a given moment.
Building the philosophy
Compensation philosophies are usually drafted jointly by company executives and the human resources team. A number of factors should be taken into consideration during the development phase, including the company's size, financial position, industry and objectives. Also important are market salary data and the level of complexity involved in finding the right talent.
As noted, compensation philosophies typically address:
- What (types of compensation).
- Why (reasons for the compensation).
- How (strategies for supporting the goals of the organization).
- How much (quantifiable basis for payment).
- How often (frequency of disbursements).
You'll need to review your compensation philosophy from time to time to ensure it echoes current market conditions affecting your business. For example, when there's a shortage of skilled workers, you may need to pay a higher salary in order to secure the right fit. You would also need to update your compensation philosophy so that it supports this need.
Further, the philosophy should promote compensation policies that are equitable, transparent and perceived as fair by employees. These policies must comply with applicable federal, state and local employment laws. Also, you'll need an effective strategy for communicating the philosophy and related policies to employees.
In conclusion, it's critical for businesses to have a well-stated compensation philosophy, as it not only helps foster a culture of transparency and trust but also enables the creation of a rewards strategy that aligns with business goals.