The Complete Guide to Creating a Compensation Philosophy

The process of developing a compensation philosophy for your organization may appear daunting because the term “philosophy” is a colossal concept in and of itself. To ease the pain and simplify the process, we've broken down each component of a compensation philosophy and put together a comprehensive guide. In this guide, you will find insights and examples to help you and your leadership team establish the foundational framework for your compensation strategy.

Understanding Compensation Practices

Determining Total Compensation: Salary + Bonus

Begin by dissecting the various components of compensation you offer for your employees, including salary, bonuses, benefits, and equity. Once your team determines every part of the total compensation package your company can or will offer, write an explanation of how each one of those compensation pieces will be distributed to employees across the company.

  • Example:

In our growing tech company at this stage, leading compensation includes ongoing cash (salary) and equity for tenure (stock). We’ve defined what our competitive market is and backed into a formula where for this level and position, employees earn a certain percentage of their total compensation package as salary and a certain percentage as equity.

Setting Compensation Thresholds

Determine how you'll set salary ranges for each role within your organization. Identify your sources of compensation data and list competitors you wish to benchmark against to ensure you aren’t losing talent to them.

  • Example:

We have sourced compensation data across comparable markets and companies to determine baseline salary bands for the various jobs within “Your Company.” Competitors we pay closest attention to include (list your competitors).

Define Your Pay Philosophy

Creating a Compensation Philosophy

Your compensation philosophy is the cornerstone of your strategy for hiring, retaining, and rewarding employees. It outlines your compensation goals and the strategies you have laid out to get there.

  • Example: Our compensation policy sample reflects our aim to compensate all employees at the competitive rate for their level and experience at the time of hire, accounting for potential variations in the level of contribution, skill, and experience where necessary.

Ensuring Pay Equity

Implement measures to ensure you maintain an equitable pay structure for all employees. Avoid making offers based solely on candidate or employee expectations.

  • Example:

To ensure pay equity, we do not make offers based solely on candidate or employee expectations; every new hire should come in at the floor of the corresponding salary band for their role and level. We will increase offers if the candidate has additional role-relevant experience. We also evaluate pay equity in our bi-annual performance review to ensure competitiveness and that individuals are paid in line with their market rate and peers.

Determining Salaries and Equity

Establish guidelines for determining the level and starting pay for a new hire, considering factors like experience, education, certification, and skills. It's crucial to define how equity will be distributed among employees as well.

  • Creating Compensation Guidelines Example:

We create salary bands for each level, determining the new hire level based on matching experience, education, certification, and skills to the requirements of a role and level. Similar to salary, we create equity bands for each level; the new hire level of equity is determined by matching experience, education, certification, and skills to the requirements of a role and level.

Understanding Total Compensation with Bonus Programs

Do you offer bonuses? If not, do you plan to in the future? If you do, what's the frequency, how is it distributed, and will it be variable? Understanding how bonuses fit into your total compensation is crucial.

  • Example:

At this time, we do not offer an annual bonus program as part of our total compensation. Due to our early stage, we decided not to introduce additional compensation variability, but we are continually evaluating our programs, and will always investigate and communicate if and when a bonus would be applicable.

Handling Exceptions

This document aims to be comprehensive, but it's important to allow for flexibility in hr. After all, h does stand for “human.” Provide examples of compensation philosophy to explain the conditions under which you might make exceptions to established compensation rules.

  • Example:
We will negotiate compensation, but will apply the same principles as the individual contributor compensation to determine the non-profit market rate.

Who is Involved in Creating and Executing the Compensation Philosophy Template?

Identify the team members who will have a say in the compensation plan for each new hire, 

This may include: Head of People, Executive Officer, Head of Function, Hiring Manager, and maybe General Counsel and Head of Finance.

Establishing New Hire Compensation Rules

Levels and Pay Structure

Creating a leveling framework is the first step in establishing new hire compensation rules. You then need to decide if and how those levels will help determine employees' compensation.

  • Example:
Levels correspond to a set of expectations for performance at the level of pay, based on scope, autonomy, and the type of work being performed, following your company's established pay bands. The compensation is similarly adjusted to align with these expectations based on market data.

Criteria for Determining Level and Pay

Identify the most valuable skill sets for your organization and clarify which factors won’t be taken into consideration when determining level and pay. It's essential to understand what does compensation means in terms of skill and experience.

  • Example:

We consider factors such as experience, education, certification, skills, or other factors that correlate with role expectations or requirements. Years of experience will not be a binary factor in decision-making; it is just an indicator of potential experience and skill match.

Approaching New Hire Offers

Starting Negotiations and Firm Compensation Policy Sample

Determine where you'll start negotiations for new hires and set firm limits for counteroffers, adhering to your compensation policy sample.

  • Example:
All new hires are expected to start at the bottom of their compensation range. In the event a candidate is asking for additional compensation, "Your Company" will use the following philosophy to determine whether to move that person up in pay. There is room in the range to offer more pay, but pay increases must not exceed 5% beyond an existing employee's salary.

Promotion Guidelines

Define clear promotion guidelines based on skills, scope, readiness, and alignment with company values.

  • Promotion Framework and Compensation Guidelines Example:

Promotions occur when employees demonstrate skills commensurate with the next-level role for a minimum of six months, when the role's scope and work availability support it, and when we would consider hiring the employee for the next-level role externally. Additionally, the individual must embody our company values.

Handling Salary Changes for Promotions

Outline how salary changes work when promotions occur within your compensation guidelines example.

  • Managing Salary Adjustments in Compensation Guidelines Example:

When a promotion occurs, the person's salary moves to the bottom of the new role and level. We don't prescribe a specific percentage increase for promotions. If an employee is already paid at the bottom of the new level or range, they may not receive an increase.

Non-Promotion Increases

Specify when non-promotion increases are given, considering performance and market changes.

  • Example:
Generally, non-promotion increases occur if an individual has consistently displayed strong performance, or there has been a market increase for the individual's salary. However, certain checks are in place to ensure the increase aligns with similar peers and doesn't harm business operations.

How We Pay for Performance

Guiding Principles for Paying for Performance

Provide a general guide for paying for performance, indicating expectations based on pay levels.

  • Example:

IF UNSURE, always go to the lowest level & move up for strong performance. Individuals will start at the floor of their level and range and chosen segment. This approach is applicable to low to mid-pay range employees, those at the midpoint, and those in the mid to high range.


Discuss equity refresh programs and their relevance to total compensation

  • Example:

At this time, we do not offer an equity refresh program as part of our total compensation. However, we are actively evaluating the options and timing of a program to ensure the long-term competitiveness of our employees.

How to Run a Calibration

Calibrations are used to ensure the entire company is aligned on what performance means at each level. Here are some best practices for implementing a calibration process.

  • Example:

Be Sure You Have at Least the Beginning of a Leveling Guide in Place; this can be edited and altered if the group agrees during calibrations.

Split Your Organization Up Into Logical Groups Based on Work and Level; typically, it'll be your junior/senior technical & management, and the junior/senior non-technical and management, such as grouping levels 1-3 of engineering.

Communicating Compensation Philosophy

Clearly communicate your compensation philosophy and template to your team to ensure alignment and understanding.

  • Example:

"As part of our compensation review, we will be holding calibration sessions with managers and leaders on employees' levels and performance. The goal of these meetings is to ensure all employees are competitively compensated based on their role and the expectations of their levels.

Managers, we will have a meeting to review how the calibrations will flow and to explain what is expected of you. We have added blocks of time to your calendars and will be sending out a leveling framework guidance in advance of these meetings.

Please let us know if there are any questions!"

Conducting Calibration Sessions

Detail the steps involved in hosting calibration sessions and making compensation changes.

  • Example:

Have a sheet with all employees in their groupings, with columns for name & start date, manager, role/title, level, notes on performance, final calibrated level, and optional columns for current salary and suggested new salary. After the session, calibrated levels should be updated wherever the source of truth is, such as Workday, HRIS, Gusto, etc.

Compensation changes should be reviewed by execs. If not approved, let the manager know. If approved, let the manager know, draft a letter of pay change for the employee, and have the manager deliver the letter to the employee before the effective date.

There you have it!

By following these guidelines and taking inspiration from the examples provided, you can approach the task of crafting a well-defined compensation philosophy with confidence. This will help your company attract and retain top talent and maintain a fair and equitable approach to compensation practices. Good luck on your journey, and as always, if you hit any road bumps along the way, feel free to reach out to our team of comp experts.

Kaitlyn Knopp

Kaitlyn is a renowned compensation expert, with experience as an analyst and leader of compensation teams in the tech industry with companies including Google, Cruise, and Instacart. Her passion for equitable compensation and efficient systems led her to create and launch Pequity, built on the principles of fair pay and opportunity for all.


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