Do your employees understand your company’s compensation philosophy? That was a question posed to human resource managers in a recent WorldatWork survey, Compensation Programs and Practices. According to the survey, almost one in five employers believe that most of their employees have a basic understanding of how their pay is determined. However, nearly half of employers in the survey estimate that most of their workforce has little or no understanding.

Those results might not be surprising in light of another survey result: Only 62% of employers have a written compensation philosophy document to share with employees. Nearly one-third said they have an unwritten philosophy, and 7% confessed they don’t have a compensation philosophy at all.

Common Pay Target

In practice, the majority of employers simply aim to set pay at the median for a given job category in their labor market. But just paying a median wage, if it can be called a compensation philosophy, isn’t one that will excite most employees if it’s explained to them as such.

Still, nearly the same percentage use some form of variable pay, typically a bonus, to reward exemplary performance. Presumably this reflects a compensation philosophy that not all employees in the same job category should be paid the same every year.

Though most employers tell employees (or at least imply) that they will be rewarded if they achieve certain goals, nearly a third say they plan to give bonuses even to those who didn’t achieve performance expectations. While such employees might appreciate the bonus, their employer loses all credibility in the process.

CEO Pay Multiples

The amount of pressure on publicly held companies to be clear about their compensation philosophy is about to explode, and it could spill over to some smaller companies. That’s because under new Securities and Exchange Commission rules, public companies beginning in 2017 will be required to report the ratio of their CEOs’ pay to that of median employee pay.

That multiple has been estimated at 300, and executive pay has risen at a much faster rate than typical employees for many years. When the figures start being reported, sensitivity to how compensation levels are determined will grow.

Here are some compensation philosophy questions to consider, then resolve and communicate to employees:

• Are small annual raises a trap? Many employers have dropped the practice of spreading around modest (for example, 2% or 3%) raises broadly, because it limits funds available to give substantial pay raises to top performers. Also, the value of a job doesn’t move in lockstep with inflation (even when inflation is low, as it has been in recent years).
• Are you using the right benchmarks? While salary surveys can tell you average pay levels for particular jobs in your labor market, they can be misleading. That’s because in your own organization, an employee whose job pays, for instance, $40,000 on average in your community, might be worth a lot more — or less — to you because of factors unique to your organization. An employee who understands his or her value to you, particularly when it’s high, probably won’t be content with pay that simply matches a market average.
• What employee behaviors are you rewarding? It’s important to establish a clear link between the activities you’re rewarding and your strategic goals. For example, if your goal is to raise employee skill levels to equip them to assume greater responsibility, are they rewarded for acquiring those skills, or simply performing well at their existing jobs?
• Is your incentive system overly complicated? It may be tempting to devise a bonus system that touches on every possible metric of employee performance. But employees aren’t finely tuned machines that can calibrate their efforts precisely in response to multiple incentives. If they feel as though they’re being pulled in too many directions, or don’t really understand the formula, the bonus will lose potency.

Why Communication Matters

After you’ve reviewed and perhaps revised your compensation philosophy, communicating it to employees is crucial. They consider the manner in which you pay them as the acid test of what you want from them. Intangibles matter too, of course, like the quality and tone of the work environment. If pay practices are a mystery, you lose on two counts: Employees don’t like being kept in the dark, and they won’t know which behaviors will bring tangible rewards.

Simply describing your compensation philosophy in an employee handbook won’t get the job done. While that’s a necessary starting point, discussing it directly with employees and answering their questions, generally in the context of a performance review, makes it more comprehensible.

Finally, be sure employees understand all of the elements of their compensation, and the philosophy behind it. If their paychecks represent, for example, only 70% of their total compensation when the value of benefits is added in, it’s important for them to understand that. It will also give them something to think about if they’re tempted to seek a job with another employer because they’ve heard the wages are good, without knowing the whole story.