A clearly defined compensation philosophy is a key input for effective compensation design. Not only does it serve as the basis for almost all compensation decisions, it is also a valuable tool for communicating internally and externally the company's values and goals and how they are reflected in employee compensation. And despite its importance, compensation philosophy can be overlooked as a component of a compensation plan or simply a simple check-the-box exercise.
Indeed, like mission statements, philosophy statements are somewhat abstract and evolve (or update), requiring companies to consider complex questions that may not have clear answers. This is no easy task. This can be particularly challenging for companies operating in a fast-paced environment under pressure, with real business risks and many other priorities to focus on. Nevertheless, compensation philosophy is an important element of an organization's overall talent management strategy.
Breaking the reward mindset
In its simplest form, a compensation philosophy summarizes the guidelines for an organization's compensation program. When it is relevant and done well, it is informed by a thorough and continuous assessment of organizational culture, strategy, and human capital needs.
The structure of compensation philosophies varies by company and industry, but generally addresses the following key goals:
- Document the purpose of your compensation philosophy.
- Define appropriate competitive reference points.
- Explain the role of different elements of compensation.
- Determines the relative emphasis of compensation elements.
- Clarify the relationship between talent, compensation programs, and company purpose/values. and
- Outline company-specific salary considerations.
While trends and best practices will certainly create overlap in compensation thinking across all industries, subtle differences between companies within an industry can create a competitive advantage. Taking the time to carefully consider each item above is critical to the development process, and once defined, each item must be reflected and made explicit in the overall compensation design.
Leverage this framework to develop or diagnose your compensation philosophy
Below, we introduce each element of a compensation philosophy and suggest important questions for companies to consider when developing their policies. The resulting compensation philosophy results demonstrate how answers can be translated into actionable items to drive compensation design.
| Framework for formulating compensation philosophy | ||
| goal | Questions to consider | Results of compensation philosophy |
| Document the purpose of your compensation philosophy | What is the ultimate purpose of the compensation program?
What are the key goals you want to achieve with our rewards program? How do we use compensation to support our mission and strategic goals? |
Goals centered on attraction, retention, motivation, and collaboration with shareholders
Additional goals that help strengthen the culture (e.g., teamwork, mission, purpose, stakeholder alignment, etc.) |
| Define appropriate competitive reference points | Who do we compare ourselves to within the market?
Which business and human resources criteria are most relevant to the development being compared? Does it vary by level or function? Where should salary levels be set in relation to the competitive market? How should the salary position of the components of total compensation be differentiated? |
A peer group of comparable companies selected based on industry, size, business, and mission similarities.
A clear strategy centered around a benchmarking approach at all levels, taking into account the relevant labor market Remuneration standard points that serve as guidelines when formulating salary systems and guidelines |
| Explain the role of different components of compensation | What role does each component of pay play in achieving the stated goals?
What different behaviors do our short-term and long-term programs encourage? |
Clearly explain the purpose of each component of pay and how each component aligns with stated goals
Communicate the purpose of each component of your paid program |
| Determines the relative emphasis of compensation elements. | What is the relative emphasis of each component of pay (base pay, incentive pay, etc.)?
What is the relative emphasis of each type of compensation element (fixed vs. variable, short-term vs. long-term incentives, etc.)? |
Expression of views regarding the priority of remuneration elements in relation to their proportion in total remuneration
Communicate the priority of each compensation goal |
| Clarify the relationship between talent, compensation programs, and company purpose/values | How does our rewards program connect to our purpose/mission?
What are the key competencies we look for in our employees? Do these competencies support our core values (integrity, respect, etc.)? |
Ensuring that the remuneration philosophy and underlying purpose and statement are connected to the company's mission, purpose and values.
Provide ongoing communication about what matters to your organization |
| Company-specific salary considerations | What company-specific factors should we consider when determining salary?
What processes can we put in place that are consistent and defensible? Under what circumstances should these processes be updated/reevaluated? |
Clarify how compensation is determined
Configure when to review process adequacy Provides additional opportunities to connect processes and decisions to culture, mission, purpose, and key goals |
continuous evaluation
Once a compensation philosophy has been developed and the principles have been reflected in the design of the compensation program, it is important for companies to continue to conduct annual reviews to ensure that the compensation philosophy remains relevant and is delivering the desired results. Below are some examples of key compensation program goals and potential analytics that can be used to demonstrate whether a company is achieving its desired goals. There are also various tools that can assist in the monitoring process and diagnose potential problems.
| Annual Compensation Philosophy Evaluation Guide | |
| Main purpose | potential analysis |
| Attracting key talent that helps advance our mission and purpose | Review of remuneration range to ensure competitiveness
Review of compensation designs to assess competitiveness and isolate differentiated designs used during recruitment Human capital metrics (e.g. success rates for top candidates) |
| Retaining proven talent | Reviewing individual compensation systems to understand competitiveness
Review of current equity grant profiles (unvested, equity value, leverage, vesting events) |
| pay according to performance | Metric correlation analysis
Performance-based analysis Operation plan execution analysis |
| Aligning the interests of employees and shareholders | Sensitivity analysis of stock assets
Review of stock ownership guidelines |
Of course, not all aspects of a compensation philosophy require specific quantitative analysis to confirm their effectiveness. In some cases, there is a mismatch between company culture and strategy, and a lack of alignment between compensation philosophy and compensation program design can become very apparent. (For example, if you have a strategy of consistently paying below-median salaries but are having problems with retention.) Most importantly, however, companies should periodically revisit their philosophy, and this process will allow boards and executive decision-makers to optimize their pay programs accordingly.
In summary
Although it can be difficult to define, a remuneration philosophy provides a consistent framework for a company to work within by ensuring that all pay decisions are based on the same values. It is up to compensation committees and executives to ensure compensation philosophy reflects company culture and evolves over time.
