The Well Written Compensation Philosophy

12-2-13-Blanchard.pngTaking tests would certainly be easier if you had the answers beforehand. What if you also had the ability to determine those answers? Well, that is exactly what compensation committees and bank executives should be thinking when they develop a written compensation philosophy. Put in the effort up front, so when the tough decisions have to be made, you already have the answer key developed. A well thought out and well documented compensation philosophy makes life easier. So where do you start?

Strategic Discussions

If you don’t have a written compensation philosophy, I suggest you start discussions with the compensation committee and the CEO (add other key executives if appropriate) to get the ball rolling. Talk about the organization’s beliefs surrounding compensation and how you want to strategically position your compensation programs to help achieve your goals. And remember, there is no right or wrong compensation philosophy. You get to decide your unique answer.

Focus on Total Compensation

The philosophy should focus on the total compensation package. That means base salaries, incentives (cash and equity if available), benefits and perquisites. It should cover what programs you have, who qualifies for those programs, and where you want to be positioned compared to market. Ask yourself some critical questions, such as:

  1. What are we trying to accomplish with our compensation programs?
  2. Do we believe in pay for performance?
  3. Should certain employee levels qualify for certain compensation programs?
  4. Where do we want to be positioned compared to market?
  5. What can we afford? (Don’t forget this one.)

These questions will help get you started down the road that is right for you.

Put it on Paper

Once you have determined the answers to some key questions you can start to draft a philosophy statement. Be sure you cover all compensation components from a high level and discuss how they fit into the complete picture. For example, if you start with base salaries and think they should be positioned at market competitive levels for fully functioning employees, then you need to take the next step and determine your market and your job expectations. Often, specific percentile positions (i.e. 50th percentile) will be mentioned in philosophies and other times ranges may be utilized. Be as specific as possible (at least internally). Some organizations will choose to lead or lag the market for specific purposes. As an example, a very performance-driven company may choose to slightly lag the market on salary, but provide high incentive opportunities based on performance that would allow the employees to potentially earn a total compensation package that is above market. This will likely attract a certain type of employee and should be communicated at the time of recruitment.

Test Your Philosophy vs. Current Reality

Once you have drafted your philosophy, you should test your goals against reality. Start by asking yourself: Are we currently practicing what we just wrote down? Or will this require a cultural shift? Some organizations incorporate a reality philosophy and an aspiring philosophy. For example, maybe you want to target salaries between the 50th and 60th percentiles of the market, but you realize you are currently paying closer to the 40th. You can’t afford to make huge adjustments all at once, so you develop a plan to get there during a period of time. This has been very common in recent years where performance challenges in the banking industry created the need for a re-set button for a lot of compensation philosophies.

Communicate Your Philosophy

Once you feel you have developed a philosophy that works for your organization, you need to communicate this philosophy. Your human resources department and managers will be critical in helping with this phase. Every employee should understand your compensation philosophy and where their specific position fits. For example, if you have determined that certain levels of employees (i.e. senior vice presidents and above) qualify for participation in a long-term incentive plan, then use this as a motivator and performance driver for those employees at the vice president level or below to aspire to that level and be rewarded for that achievement.

Put it Into Practice, Revisit and Revise

Once the philosophy is developed, written, tested and communicated, you need to keep it current and use it to make life easier. Those making decisions around hiring, annual salary increases, incentive program payouts and executive benefits should annually go back to the compensation philosophy and be sure their decisions are consistent with the stated philosophy. Each year, the compensation committee, CEO, and human resources department should review the philosophy and determine if externally or internally things have changed significantly enough to require a strategic change. It is OK to revise the philosophy for strategic purposes from time to time, but it should generally be looked at as a document of guiding principles that provides more answers than questions.