How to Create an Effective Employee Compensation Policy

For legal protection and good business sense, every company should have an up-to-date employee compensation policy. What is the status on yours? An organization should not wait for dire circumstances, such as a pay inequity lawsuit, to write down or update their employee compensation policy. All organization leaders should create a written policy document or refresh their existing one for legal protection, and as a guideline or framework for the company’s compensation program. Below is a list of helpful tips and tools for creating an effective employee compensation policy that is specific to your organization.

Define Your Compensation Philosophy

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First, each organization should develop a compensation philosophy. Information on how to do so is covered in detail in a separate blog post but, in brief, your compensation philosophy states how the organization’s guiding principles influence the employee compensation plan.

After you develop your philosophy, you can move on to creating your employee compensation policy. The following are some key points on how to prepare for writing your policy:

  • Determine your place in the market. Know where your organization’s compensation sits relative to the market where you compete for your talent. This may include factors like your industry, geography or size of organization, to name a few. Our post on how to set salary ranges can help with that process.
  • Select the types of compensation. Beyond base salary, what other forms of compensation does your company offer, when and why? These can include bonuses, such as individual commission and incentives, team incentives, company-wide incentives, benefits, fringe benefits, stock/ownership and others. Review each type and determine if one or a combination of these options work for your organization and who in the organization will be eligible for each type of compensation.
  • Review your process. Think about the process you’ll use for balancing internal pay equity against market competitiveness. This will include some research about using a straight market-pricing philosophy versus a job evaluation tool to put similar jobs within pay grades. There are advantages and disadvantages to each approach.

write Your Employee Compensation Policy

Once you’ve done your research on where your current compensation stands relative to the market versus where you would like it to be, it’s time to write your compensation policy document. Here are some guidelines on how to write a clean and clear policy:

  • Watch the details. Be specific, but not so specific that you limit your ability to manage the program. For example, you may want to state that the organization will review market data on a regular interval, rather than state the specific timeframe. This will give the organization the ability to do it more or less frequently than in the past depending on business necessity.
  • Communicate your company’s commitment. Your compensation policy should outline the organization’s commitment to equitable and fair pay practices and reference your organization’s intent to comply with all applicable laws and acts.
  • Gain approval. Generally, it is the board of directors that approves the final policy, but these aren’t the only people involved in developing your policy. The top executives such as the CEO, COO, and CFO have input to the overall goals and objectives of the compensation program. The human resources professional serves as the expert regarding items to be included in the policy. Your organization may also choose to create a compensation committee consisting of individual stakeholders from different departments including some managers and employees as an internal control measure, as well as an employee engagement strategy.
  • Make it real. Your company policies should be reviewed and approved by the executive team and/or board of directors. Meeting minutes or signatures to prove acceptance of the policy are a good idea.

Administration After the Policy is Done

It is important to maintain your compensation program after your compensation policy is written so that it stays equitable, relevant, and timely. Here are answers to common questions regarding this process:

  • Who will be responsible for the administrative work of reviewing job evaluations and market data? The HR department will most likely maintain the compensation program. But many times, in lieu of an HR department, the administrative staff or accounting department may be in charge of the task.
  • What will be the process and timing for submitting new job evaluations? Generally, this is done as needed, but some organizations require these be submitted within certain timeframes to maximize efficiency.
  • What will be the process and timing for obtaining and reviewing market data? Most companies analyze market data on an annual basis. However, your organization may need to look at market data more frequently, especially if you are in a high growth mode or if you are in an industry or market where salaries are rising faster than the national average.
  • What will be the process and timing for adjusting positions or employees based on market data? This should tie in closely with the review of the market data. However, some employers would be wise to look for trends rather than respond too quickly to market fluctuations.
  • What will be the process and timing for adjusting employees pay based on performance or longevity? This should be directly tied to the performance evaluation process. Many organizations do the performance and/or longevity increase at a separate interval than market adjustments so the differences between the two types of increases are easier to communicate with employees.


Stacey Carroll, MBA, SPHR
Director of Customer Service and Education at PayScale, Inc.

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