Compensation philosophy

What is a compensation philosophy?

A compensation philosophy is a statement that outlines how a company approaches employee compensation. At a high-level, it defines the company’s strategy for recruiting, retaining, and rewarding talent—ensuring that compensation is consistent and fair across different roles, demographics, and locations.

Compensation philosophies are not a thorough list of compensation structures and pay ranges for every role, or a rundown of all the rewards on offer. Instead, they serve as a framework for determining salary benchmarks, variable compensation, equity, and other benefits. 

The guiding principles should address:

• Market positioning: Whether employees are paid at, above, or below market rates.

• Values: How the company addresses pay transparency and equality.

• Equity: How equity compensation will be granted, and to whom.

• Performance: How incentive pay is linked to employee or company performance.

• Total rewards: Includes base salary, bonuses and incentives, equity grants (such as stock options), and other benefits like health insurance and paid time off.

• Compliance: Ensures the company is adhering to labor laws and regulations.

A well-defined compensation philosophy provides transparency, helping employees understand the factors that influence compensation decisions. It creates alignment between employee incentives and business objectives, and supports hiring and retention by positioning the company positively in a competitive job market.

How to create a compensation philosophy

Creating a compensation philosophy is usually a collaboration between the executive team and HR professionals, ensuring the framework accurately reflects the company's values and meets market expectations. This typically involves taking company finances, industry standards, and market salary data into consideration.

The earlier you begin developing your compensation philosophy, the more seamless and equitable your hiring will be. Your philosophy should be flexible enough to grow as your business does, but you can always revisit it to ensure you stay competitive.

Here are the questions you need to consider 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 the market competitive or is it relatively easy to hire in general? Are there specific market conditions or other challenges in hiring and retaining employees?

• What industry are you in, and what are the salary 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 talent benchmarks for companies of your size? 

• Where do you want to position your employee compensation relative to 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 practices for discrepancies by groups such as gender and race? Will you have a compensation policy on pay transparency for candidates and existing 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 who occupy certain job levels or functions? 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?

High-performing salespeople are typically compensated in part through incentive pay (also known as “ variable compensation”). But what about everyone else? Do you want to establish a broader approach for rewarding employees, such as making pay performance-based?

When to update a compensation philosophy

Your company’s compensation philosophy acts as a flexible framework for defining your compensation strategy and building a more detailed compensation plan. 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 desperate 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 offer more competitive pay to stay competitive in the market.

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. 

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