Compensation philosophy

What is a compensation philosophy?

A compensation philosophy is a statement about two things: what your company is trying to achieve through employee compensation and how you intend to get there. It defines, on a high level, your strategy to hire, retain, and reward talent. 

Why a compensation philosophy is important

A compensation philosophy acts as a framework for all your decisions around salary, variable compensation, equity, and certain benefits. It’s not a thorough list of compensation for every role or a rundown of all the rewards you’re offering. Instead, it’s a set of guidelines for how competitive you need to be, how you’ll stay fiscally responsible, your approach to big comp questions like location and bonuses, and how you’ll break your packages out into cash vs. equity. 

Besides defining your compensation strategy, a good compensation philosophy will be a set of guardrails for benchmarking roles and creating offer letters—saving you time. It will be the guiding light as you make your more specific compensation plan. It should also help you stay equitable in your hiring by keeping you consistent and transparent. 

How to create a compensation philosophy

So how do you put your philosophy into place? First off, start ASAP. The earlier you begin, the more seamless and equitable your hiring will be. Your philosophy will be flexible enough to grow as your company does, but you can always revisit it.  

Typically, HR works with executive leadership to develop a philosophy. Here are the questions you need to ask to get started.

How are you defining your target market?

Target market positioning forms a key part of your philosophy.

• What’s your labor market for talent? Is it very competitive or is it relatively easy to hire in general? Do you have specific challenges in hiring and retaining employees? What will you pay employees relative to the labor market? 

• What industry are you in, and what are the compensation benchmarks in that industry? Where are you located, and what is the cost of labor where you’re hiring? 

• What size is your company, and what are the benchmarks for talent for companies your size? 

• Where do you want to position your compensation versus the market?

Some companies might target a single percentile of the labor market for all types of compensation, while others might set different percentiles for each type. For example, an early-stage company without much cash to spend might set a lower target market position for salary while setting a higher target for equity. 

Sample early-stage philosophy

Other companies might want to set different targets for different job areas, based on how competitive the labor market is and how important a job area is to your success.

Sample philosophy based on job area

What values do you want to express?

Will you build in goals to regularly audit pay for discrepancies by groups such as gender and race? Will you have a policy on pay transparency for candidates and employees? 

What’s your approach to remote pay?

Will you pay the same no matter where your employees are working across the U.S., or will you vary your compensation based on the local cost of labor? Geo-differentiating can help a startup save money on salary, but you might decide to pay one rate to hire and retain great talent—or you might decide not to hire outside your metro area. Or you might do some research and discover that for your company, the cost of state and local compliance and administration across several states is just too high to hire outside of the HQ metro area.

What will your equity plans look like?

Will all employees be eligible to receive equity compensation or just people at certain functions or levels? If you’re early-stage, how will you compensate your first employees compared to down the line? How much weight will equity have in an overall compensation package, and will this vary by job area?

What will your incentive plans look like?

Salespeople typically are compensated in part through incentive pay (aka variable compensation). What about everyone else? Do you want to establish a broader approach to linking pay and performance?

When to update a compensation philosophy

Your philosophy acts as a flexible framework to build a more detailed plan around. But you should review it regularly to make sure it’s still effective as your business grows and the market changes. 

There may be situations that require you to change your philosophy, either temporarily or permanently. Say you’re in dire need of product designers. You may need to examine your current compensation philosophy and decide to change your approach to the design role, so you can hire faster and keep your roadmap on schedule. 

Or maybe your HR and recruiting teams have noted that you’re losing more candidates to competitors over the past six months than you expected to. You might decide to bump up your market position permanently to get and stay more competitive.

Some companies update their compensation philosophies quietly, keeping just their new hire pipeline and existing employees in the loop. Others make it a press opportunity. Amazon was one such company. In February of 2022, leaders announced that in order to compete for top talent, they doubled their maximum base pay for corporate and tech workers to $350,000.

Compensation philosophy examples

How exactly do compensation philosophies work in practice? Here are a couple of (hypothetical) examples to consider. They’re both in healthtech, but they reflect very different philosophies.  

Company A is a well-funded Series D startup that’s busy building infrastructure to scale. They decided early on to compensate engineers more highly than other employees, as they’re essential to success. They aim to pay engineers in the 75th percentile (better than 75% of companies of the same size in their region) for salary. They’re looking to pay all other roles at the 50th percentile of the market. To make employees feel valued, Company A has an annual bonus plan for everyone and grants equity at the 50th percentile across the board.

Company B is a seed-stage startup that launched last year and has raised $800,000. They’re only able to pay salaries between the 25th and 50th percentiles, and they’ve chosen not to pay an annual bonus. However, hiring the first employees at such a small company comes with the opportunity to offer significant equity. They’re targeting the 75th percentile of the market for their first five hires and have decided to revisit their philosophy in a year. 

Download the guide to building an effective compensation strategy

Learn how to strategically plan and implement a data-driven compensation strategy to attract and retain talent, manage financial resources, and align your company’s goals with employee incentives.