Managing the Next Generation of Compensation Strategies

Compensation practices are starting to go through a major transformation that is driven by the need to more effectively engage employees. It’s enabled by flexible cloud technology solutions that allow companies to rethink traditional compensation approaches, and it’s tempered by increasing demands for equitable compensation across employees.

This transformation is increasing the demand on compensation professionals to manage three challenges:

Maximizing the value of novel compensation methods that leverage things like spot bonuses and nonmonetary rewards
Giving managers greater autonomy to make compensation decisions while still ensuring these decisions are appropriately made
Ensuring employees perceive compensation practices as fair and motivating.

To understand how organizations are navigating these changes, the Human Capital Management Research team at SAP SuccessFactors is conducting extensive interviews with compensation professionals, managers and front-line employees. The results suggest that, to survive major shifts in pay philosophy and practice, companies must be proactive in preparing for them. This may require significant adjustments in how companies plan for, monitor and communicate compensation decisions in general. Here’s a peek into 4 lessons learned so far.

Lesson No. 1: Good decisions don’t just happen

Managers are being given more autonomy around compensation decisions. This is in part due to organizations’ increasing use of compensation methods that are heavily manager driven, such as on-the-spot awards. It also is related to some companies moving away from clearly defined methods for assessing employee performance contributions. We frequently heard that, as long as managers stayed within a given budget, they were permitted to distribute awards however they saw fit. This was particularly true for spot awards, for which oversight of manager decisions tended to be reserved for large monetary amounts.

Given such limited oversight, when asked how companies ensured awards were equitably distributed, it was common to hear that doing so was not deemed necessary. The reasons companies reported for not conducting systematic reviews of spot awards included:

“Because the amounts (associated with spot awards) are relatively small”
“Because ongoing recognition programs are not widely used in our organization”
“Because we’ve never had a complaint about distribution inequities"
“Because we trust our managers to do the right thing.”

The apparent lack of concern shown by some companies toward how managers make pay decisions could create problems in the long-term. Decision-making research suggests that even well-meaning managers can make biased decisions, and even “small” awards can negatively impact employees’ motivation and perceptions of fairness when distributed inequitably. Also, a lack of explicit complaints about inequitable decision making should not be taken as evidence that decisions are equitable.

51% of women responding to a survey from the Institute of Women’s Policy Research reported that the discussion of wage and salary information in their workplace is either discouraged or prohibited. As Maya Raghu, director of workplace equality and senior counsel at the National Women’s Law Center described in an interview with CNNMoney, “Pay secrecy is one of the things that contributes to pay discrimination and the wage gap. This is when you’re in a job and your employer is saying, ‘You can’t ask about wages, you can’t disclose them to each other and if you do you will be penalized’ — and many times the penalties include being fired.”

It is advisable that companies conduct regular reviews of spot awards and bonuses for potential demographic issues, just as they would review base salary and other components of the compensation package.

Companies can further mitigate the likelihood of potential issues by providing managers with training and resources to help them make effective decisions. Some examples include educating managers on the compensation processes and philosophies used across the entire organization, providing guidelines for defining award-worthy behaviors, and training managers to recognize biases and to keep their decision-making consistent and equitable.

Lesson No. 2: Good compensation conversations don’t just happen

Companies work hard to ensure that compensation decisions are fair. Perceptions of fairness positively affect employees’ performance, satisfaction and motivation. Research also has shown that employees’ concerns about how their salaries were determined accounted for more variance in job satisfaction rates than did the level of those salaries. But it is unlikely that employees will view decisions affecting their pay as fair if they do not understand how these decisions are made, who is responsible for the decisions, or what they can do to influence decision outcomes in the future.

Every compensation professional we spoke with said that managers in their organizations are expected to communicate compensation decisions to employees. In other words, it was expected that managers “don’t just put it on their desk and walk away.” Many also described providing guidance to managers on how to effectively communicate pay decisions as part of their manager training. This included guidelines on things to explicitly reference during the conversation, things to avoid saying and guidance on when the conversation should occur.

But it’s also important for companies to have some method of monitoring or ensuring that these conversations take place. As one employee described, “We’re [employees] blind in terms of compensation decisions. When it comes to bonuses or raises, the supervisors and managers in my organization are the ones responsible for communicating that. They don’t do it well, it’s very vague. For example, I found out the day they were handing out the check, ‘hey, here’s a bonus.’”

Talking to employees about pay decisions can be awkward for managers if decision outcomes are negative (e.g., a decrease in pay, absence of bonus), and may be particularly challenging if the decision was made by someone other than the manager. Managers may find it tempting in these situations to avoid having conversations altogether. But avoidance will only lead to more frustration, suspicion and demotivation for employees.

Managers are much likelier to have critical conversations related to pay decisions if they are trained on how to do so. This includes making sure managers can effectively explain how compensation decisions are made to employees, regardless of their role in the decision process. Managers also should be given guidance on how to handle difficult compensation conversations, ideally including role playing exercises, to ensure they can deal with what could become very difficult conversations.

Lesson No. 3: Going ratingless changes some things related to comp decisions, but shouldn’t change everything

Numerous compensation professionals we interviewed (40%) were from organizations that had recently moved away from annual performance ratings. While this shift is not surprising, what is surprising is how many companies seemed to eliminate ratings without thinking about how they would ensure effective compensation decisions are being made without ratings to which to tie these decisions. As one compensation professional said, “We don’t believe anybody needs ranking or rating to know who their highest performers are. But the risk [of no ratings] is how you know you are creating equity across the company.”

Just because a company stops using performance ratings does not mean it should stop engaging in meaningful conversations about employee contributions, accomplishments and capabilities to inform decision making. As another compensation professional described, “We don’t have performance ratings. We just translate that information and how we perceive the value of employees to help make decisions regarding pay.”

Some best practices suggested by companies that eliminated end of year manager ratings include:

Providing managers with guidelines based on certain conditions. For example, is the employee above market? Below market? A significant contributor?
Using calibration talent reviews to categorize employees based on their relative contributions.
Using nine boxes focused on performance and potential.
Providing ongoing feedback and communication with employees throughout the year as to avoid surprises.

Lesson No. 4: If employees can’t get information about pay from you, they’ll find it elsewhere

Employees now have more means of accessing pay information than ever before. Many employees we spoke with reported frequently using sites like Glassdoor and Indeed to compare their salary with others in their own organization as well as across other companies. As one employee said, “Absolutely I seek compensation information elsewhere — mostly Glassdoor and similar sites. There’s a lot to be said for knowing your compensation and how it compares [with others].”

A concern for organizations associated with employees seeking information from these sites is that the information may be inaccurate and cause unwarranted alarm. As one compensation professional described, “I do get quite a few emails about things people saw on Glassdoor. Glassdoor is an incomplete measure. But it’s all about how you respond.”

Employees we spoke with who felt there was a high level of transparency in their organization surrounding compensation were much less likely to report seeking out pay information from external sites. Although increasing transparency on a topic that has been kept deliberately private so long is a major challenge for many organizations, failing to make appropriate adjustments in transparency philosophy and practice will do more harm than anything else. As one compensation professional explained, “With a black veil over the compensation process, problems and suspicion will always exist. We haven’t had the proper philosophical debate about how transparent we want to be on pay. It’s a difficult question. But it feels like you have to go through the pain of being transparent to come out in a stronger, better place.”

Employees who felt more satisfied with the level of transparency in their organization described things including:

Pay scales that are accessible to all employees
Published pay tiers based on ranking
Having clear bonus metrics to refer to
Feeling comfortable being able to address questions/concerns related to pay decision with manager.

Compensation has changed and continues to change in major ways. With this evolution comes the need for companies to ensure they are planning for, communicating and monitoring compensation decisions effectively — something that is often easier said than done. In a world of increasing transparency, organizations must be prepared to defend their pay philosophies and practices. To do this requires having effective processes, decision making, communication and reviews in place. When it comes to compensation, it is not a question of if neglecting these components will frustrate and demotivate employees, but when.

About the Author

Lauren Bidwell, Ph.D.

Research Scientist, Human Capital Management Research

Dr. Lauren Bidwell is an Experimental Psychologist with a specialization in Decision Making research. Her role involves driving innovative thinking and best practices around talent management and the use of technology to support effective talent decisions. Lauren has engaged with dozens of customer organizations around the world and is an active author and presenter.

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