The Basics of an Effective Employee Compensation Plan

Every manager worries about whether their top performers are happy with their jobs. It’s an understandable concern when reports find that about 71 percent of US employees are actively looking for their next opportunity.

The first solution that occurs to many managers is to throw more money at the employee. But that’s usually a bad idea—for a couple of reasons.

First, thanks to the work of Daniel Pink and others, we know that money is a fairly poor motivator. The strategy of increasing motivation through a bonus structure works by extrinsic motivation, which is far inferior to intrinsic motivation, an internal desire to do the work.

Second, in addition to not driving sustainable motivation, monetary incentives don’t cause higher performance either. In fact, they can do quite the opposite, encouraging people to cut corners, fudge data, or even compromise their ethics to earn the extra cash. Organizations from Wells Fargo to the VA have been forced to rescind their incentive programs in the wake of employee behavior that hurt their customers and caused a loss of public faith.

As I once heard Jim Collins say, “You cannot turn the wrong people into the right people with money. You can’t.”

But That Doesn’t Mean…

However, none of this gives you an excuse to pay people poorly. In fact, Daniel Pink himself rebutted a positive USA Today review of his book that ran under the headline “Raises Make Bad Motivators.” Pink noted that paying people well does in fact matter—quite a bit. He points to the passage of the book where he says that if an employee isn’t paid “an adequate amount, or if her pay isn’t equitable compared to others doing similar work—that person’s motivation will crater.”

Critically, Pink also distinguishes between (a) fair salaries and (b) incentive programs: “Providing an employee a high level of base pay does more to boost performance and organizational commitment than an attractive bonus structure.”

The Basics of a Great Employee Compensation Plan

This leads me to the approach to compensation I recommend:

Base salaries across the organization on objective compensation data from your industry. Then, instead of giving high performers bonuses, reward them with development opportunities and other non-monetary incentives.

With this setup, you remove the question of salary from the equation, so people can focus on the work. Employees understand that their paycheck isn’t influenced by the flawed perceptions of management or HR. (How do you get objective compensation data? You can figure out market rates from a plethora of sources, both formal and informal. Organizations like SHRM and PayScale offer salary data, and you can also learn a lot through the process of interviewing candidates and finding out what types of other offers they are receiving.)

The second part of this plan is rewarding your standout employees with opportunities to grow and learn. There are many ways to show an employee they are valued without issuing a bonus:

  • Send them to a conference of their choosing.
  • Pay for a training course in a topic they are interested in.
  • Put them a project that excites them.
  • Connect them with a mentor.
  • Move them to a new role with more responsibility.

As a side note, if your organization gets to a point where salaries are truly determined by objective outside measures, you may want to consider salary transparency. This approach has gained traction in recent years, and I think it’s a good idea if you can pull it off. This type of nontraditional transparency builds trust and removes any suspicion of unfairness from the workforce. (Perceived unfairness is one of the worst demotivators out there.) Take for example Buffer, which decided to implement salary transparency and even posted its salaries online. Immediately after, applications from high-quality candidates poured in. “We’ve never been able to find great people this quickly in the past,” said Buffer cofounder and CEO Joel Gascoigne.

Implementation Challenges

Unfortunately, many managers may not be able to snap their fingers and immediately implement an employee compensation plan like the one I advocate above.

It’s possible that you have limited control over the salaries on your team. Maybe you inherited a group where salaries were already inconsistent, and you can’t suddenly align them all based on market rates. It’s also possible you simply don’t have the budget to bring salaries on your team up to market rates; that 3 percent raise you have to allocate across your whole team just isn’t going to get you where you would like to be.

In these cases, work slowly toward the ideal situation. On the way there, I recommend never saying anything like this phrase I still hear fairly often: “We pay for performance.”

Your current situation may not be perfect, but do everything you can to disabuse employees of the notion that their pay is directly correlated with quarterly or annual performance appraisals. You lose credibility if you say you’re “paying for performance”: in most organizations today, roles are so codependent and enmeshed that individual output is harder to measure than ever. As a manager, you should have a clear sense of who your key employees are, but unless you can be totally scientific about tying their output to bonuses, perceptions of unfairness will remain.

It’s also necessary for some organizations to move pay up or down from market rates, and that’s not a problem as long as the adjustment is made across the board. A fast-growing tech company might pay its employees more to compete for talent, for example, while a nonprofit may be forced to pay smaller salaries in exchange for giving the employee a chance to work on a cause they care deeply about.

Either way, the most important thing is to maintain the perception of fairness by basing salaries on objective, outside data. Then you can reward your A-players by enabling them to build their skills and and grow as professionals and people.

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