Fair and equitable compensation: The foundation of HR programs

Rightly so, most HR leaders are concerned with the ever-increasing pressure to attract, motivate, engage, and retain their employees, especially those high-potential and key management ones. Accordingly, they  implement a wide variety of HR programs that are designed to do just that. However, all HR programs rely on one key assumption - that the majority of employees feel that they are being fairly compensated in relation to the performance results they have achieved and their pay level is equitable both internally with other employees in their job and externally with the outside labor market.

Read Jack Bucalo's recent column on business acumen for HR leaders.

To achieve that goal, the company's salary administration and bonus administration practices must be administered fairly which, in turn, will provide the rock-solid foundation upon which almost all HR programs rely. In the end, if a lot of employees feel that their compensation is not fair or equitable, the benefits of various HR programs, such as onboarding, recruitment, engagement, leadership, management training, and skills development are likely to be greatly diminished.

Any compensation plan, whether it is for salary or bonus administration, strives to be fair while paying for performance. Paying fairly means that the compensation amount was impartially and honestly determined in an objective manner based on merit without any favor or prejudice. Paying for performance means that the compensation amount was determined by a thorough analysis of specific performance results wherever possible, rather than a subjective evaluation by the supervisor. Lastly, external equity means that the compensation amount is comparable to others doing the same type of work in the relevant outside labor market, while internal equity means that the compensation amount is appropriately placed within the salary or bonus range in comparison to other employees within the same job and/or salary range, taking into account any performance differences.

Though existing company practices for salary and bonus administration tend to take precedence, there are several key principles that should be understood and considered for use.  Such principles fall into either a general or specific category.

Salary administration

General

1. First and foremost, fair and equitable salary administration is predicated on having accurate salary ranges that reflect the reality of the relevant outside labor market over a given period of time, which is typically for a budget year.  Without such salary ranges, effective administration of salaries is very difficult to attain.
2. Market-priced salary ranges from a reputable source that are appropriate for your exempt professional and management positions (typically nationwide) and non-exempt positions (typically from the local geographic area) are more preferable than those developed from a job evaluation system because of the direct link of the key positions to relevant outside salary data.
3. If your company advocates a pay-for-performance culture, there should be some formal or semi-formal performance review policy and practice in place, which is designed to evaluate an employee's specific performance results, especially those at the top two or three levels of management. In any case, the evaluation of performance should be supported by some form of performance documentation. In addition, making an appropriate salary increase recommendation should never be solely left up to the supervisor's verbal comments, while at least two (and preferably three) upward levels of management review should occur at all times.
4. Almost every manager has a natural tendency to want to give his or her employees a pay increase at their regular review time interval unless performance is totally unsatisfactory.  When this is not possible, it is much better to give the employee their earned merit increase percentage at an elongated time interval than it is to give him or her a lower merit increase percentage at their regular review time interval.
5. During difficult financial periods in which tight salary budgets exist, it is better to withhold or lower pay increases, or elongate the time interval between increases for the lesser performing employees in an effort to use the available monies to reward your higher performing employees.
6. External and internal inequity situations are best corrected in the Salary Administration plan, though it may take a year or more to correct the entire problem.

Specific

The salary range data will usually be provided as of a particular date. For a company that operates on a calendar year/fiscal year basis, the data will typically be effective as of or around July 1 of the current year. Therefore, the salary range data should be increased to accurately reflect the outside labor market in the upcoming year.  For example, if the market is increasing at a 4 percent annual rate and your company wants to accurately reflect that labor market in the upcoming year, the salary range data should be increased by 4 percent in July of that year. Utilizing a less than 4 percent increase will have your company lagging the market, while utilizing a more than 4 percent increase will have your company leading the market.

The final decision by the CEO of how much, if any, the salary range data should be increased will be predicated on the company’s financial ability to afford any additional salary budget expense. Therefore, all such supportive documentation and recommendations should be coordinated with the company’s CFO.

The total amount of merit/salary increase for any one employee should be based primarily on performance, with additional consideration for any external inequity as represented by his/her position in the salary range and internal inequity when he/she is unfairly compensated in comparison to lesser performing employees in the same position.

When faced with both external and internal inequities, give more emphasis to the internal equity problem.

Though merit increase guidelines vary widely from company to company, the following represents a typical set of recommended merit increases percentages and review time intervals between increases for a company with no affordability issues.

Since the division or business unit head will much prefer to spend the majority of the salary budget monies on the key positions and departments that are crucial to the upcoming business plan, HR can provide valuable departmental position-in-range data, similar to the following, to help achieve that end: 

The above data suggests that the Senior Software Developers and Software Developers are significantly behind the market and should be given higher than normal salary increases to help correct the problem. Such a salary action will minimize the risk of these key employees leaving the company.

Promotional salary increases should consist of a pro-rated merit increase along with a promotional increase percentage.

HR compensation department should work closely with the finance department to ensure that monies provided by their merit/promotional salary guidelines fit within the company's financial/budget plan.

Bonus administration

General

1. At a minimum, and consistent with the availability of budgeted bonus monies and the standard practice in the outside labor market, bonuses should be provided for appropriate technical, professional, management, and executive employees.
2. Bonus monies should be placed into the financial budget for both spot bonuses that can be utilized as needed throughout the year and annual, end-of-year bonuses.
3. Typically, spot bonuses are "triggered" by the achievement of certain important, specific performance results by an employee or team of employees, while annual bonuses are "triggered" by the achievement of certain specific division or business unit end-of-year financial objectives.
4. For management and executive personnel, salary and bonus amounts are considered together as "total cash compensation" when determining whether an employee's pay level is fair and equitable.
5. There is usually a hierarchy of ascending "target" bonus levels for each bonus plan, which is expressed as a percent of salary for each plan participant, that increases by regular percentage intervals (e.g. 15 percent, 25 percent, 35 percent, etc.) up to the executive level.
6. Recommended bonus amounts should be reviewed and approved by all management levels, prior to the review by the CFO and CEO.

Specific

Annual, end-of-year bonuses are based on the division or business unit meeting one or a mix of certain financial objectives, such as operating profit, net income, earnings per share, sales, etc., in which the target objective represents 100 percent. Typically, the dollar amount of the 100 percent target is placed into the annual financial plan and budget.

Usually, if the final financial results for the end-of-year bonus are less than 90 percent of the target; no bonus pool monies are paid out. If the final results are between 90 percent and 99.9 percent, a much lower, prorated amount of the bonus pool would become available, such as 60 percent or 70 percent. The results at or over 100 percent might typically be represented by the following chart:

Regardless of the bonus plan calculation for the total division or business unit bonus pool, what matters most is the amount of money that has been reserved by the Finance department for this purpose. If the division or business unit head desires to exceed the dollar amount, such an overage will have to be absorbed in some other part of the Income Statement.

The bonus target for any individual employee is set as a percentage of salary. So, if the division or business unit achieved a 105 percent bonus pool, the consideration of a bonus for any individual employee would typically start out at 105 percent. Then, based on the evaluation of the employee's performance results, the final percentage would go up or down from that starting point. If the employee's overall performance was far less than satisfactory, either no bonus or a dramatically lower one would be considered.

To ensure that the bonus plan continues to be perceived as an incentive for improved performance only; payouts should not be used to correct any internal or external inequity problem.

When the final bonus payout awards are determined, an updated total cash compensation amount for each appropriate employee should be calculated for use in any future compensation analyses or pay comparisons. 

Specific dollar amounts for spot bonuses should be set aside in the budget and used exclusively for that purpose, regardless of the division or business unit's financial performance for the annual, end-of-year bonus. Such bonus amounts should be administered separately and the spot bonus monies should not be commingled with the annual, end-of-year bonus pool monies.

In conclusion, if the majority of employees feel that they are being fairly and equitably compensated, they will tend to appreciate and take advantage of the full value of all other HR programs. However, if they do not feel that way, the reverse is the case and the company will diminish the benefit of such programs.

Join the HR Exchange Network community

Join HR Exchange Network today and interact with a vibrant network of professionals, keeping up to date with the industry by accessing our wealth of articles, videos, live conferences and more.

Join Now