Pay transparency continues to be a focal point this year. With 10 states having implemented salary range requirements for job listings, it’s paramount that employers manage pay policies and practices that promote fair pay in the workplace. 

As organizations incorporate these pay transparency policies, however, they must be mindful of wage compression

Wage compression, also known as pay compression and salary compression, is a pay equity issue that essentially overlooks important factors for paying employees differently, including tenure, experience, skills, performance, and education. It often occurs when new hires and tenured employees performing similar job duties receive close to, or exactly the same, compensation.

Wage compression is usually unintentional, and it can happen for a number of reasons. For example, in an effort to attract top talent during an increasingly competitive labor market, recruiters and hiring professionals may raise starting salaries. In doing so, it may create an instance of wage compression for current staff. 

Instances of pay compression can also happen during the event of an organizational merger or acquisition. Two separate organizations likely possess different pay policies, and when they combine, it’s possible for wage compression to surface. 

Wage compression is on the rise

Despite employers’ best intentions to promote pay equity, and transparent pay policies, wage compression is unfortunately on the rise. In fact, 56% of organizations reported experiencing wage compression in the last 12 months, according to a survey conducted by talent solutions firm, Robert Half.  

Obviously, wage compression poses a serious risk for organizations looking to retain and attract talent during the tightest labor market in decades. Failing to address it can result in recruiting challenges and potential turnover. 

Moreover, wage compression can result in significant workforce challenges. Employees that become aware of unfair compensation practices within their organization experience a multitude of negative feelings, including a drop in morale, comradery, and self-worth. 

To add to the severity of the situation, when wage compression issues go unchecked for long enough, they can result in legal action. Oftentimes, employees that become aware of pay inequity may attribute it to factors such as gender or race/ethnicity – and those types of claims can create serious reputational damages for a company, in addition to significant punitive and monetary damages.

Fortunately, wage compression can be solved. Organizations aware of the issue have a multitude of resources for addressing it. According to the report by Robert Half, 62% of organizations are increasing salaries for tenured staff to close wage gaps. This is but one way to help curb instances of wage compression. 

Below we dive into specifics on how your organization can correct as well as prevent future situations of wage compression.

Step 1: Review your compensation policy

Organizations eager to achieve pay equity need to have a great foundation, and that starts with a comprehensive compensation policy.

Review your policy to ensure you have clear salary ranges for departments and job roles. These ranges need to include salary caps – or ceilings that salaries cannot exceed. As recruiters seek out new talent, the salary caps will ensure that new hires are not brought in at a rate that would create pay disparities or instances of wage compression for current employees.

As you ensure equitable salary ranges across your workforce, give special attention to the midpoint for each department and its job functions. To calculate the midpoint, you will need both the bottom and top of the respective ranges.

For example, your Client Services Department may have a host of different positions, but the range for each position falls within the pay range of $50,000 and $95,000. To calculate the salary midpoint for the Client Services Department, take the bottom and top figures and divide them by two. Here’s the formula:

$50,000 + $95,000 = $145,000 

$145,000 / 2  = $72,500

$72,500 = Salary midpoint

Armed with the salary midpoint for the Client Services Department, managers, HR, and recruiting professionals can calculate where their workers fall within the range. And with this information, you can set parameters around where new hires and tenured employees should fall in relation to your established range. 

Documenting this information in your pay policy is part of the process, but the policy should also include how to address instances when new or tenured employees’ compensation doesn’t align with your established ranges. If for example, a tenured employee falls below the salary midpoint range you’ve established, give them a raise to close the gap. 

The adjustment in pay may affect your bottom line, but the increase in salary is a worthy investment for the future of your workforce – and one that will certainly cost less than replacing them. 

Step 2: Compare policy and execution 

Establishing a compensation policy is one thing, executing that policy is another. 

When designing your strategy for employee compensation and benefits, you may determine that your organization compensates 10% for tenure – that is, when accounting for compensation between workers with comparable duties, tenure could make up 10% of the difference in pay.

After reviewing actual salaries for employees of similar job functions, however, you find that you’re actually only attributing 2% of compensation differences to tenure. In situations like this, your pay policy and your compensation efforts are out of alignment.

The gap between plan and execution could be a significant contributing factor for creating instances of wage compression. It’s for this reason that organizations must audit their compensation policy against what’s really happening across their workforce. And if there not in sync, take actions to make sure they are. Issues like these can snowball and turn into serious pay disparities. 

Step 3: Conduct a pay equity audit and adjust

Next, you must understand your pay equity profile on a larger scale. Ensure you have equitable pay practices amongst your entire workforce. Pay equity audit software solutions like PayParity identify pay gaps and pay disparities at the intersections of gender and race/ethnicity.

The results from the pay equity audit can help you identify occurrences of wage compression that exist for what appears to be discriminatory reasons – and taking a proactive approach to addressing these inequities will bode well for your organization’s overall approach to fair pay practices.

Every time a new employee is hired, or an employee leaves, an organization’s pay profile changes – It is for this reason that pay equity audits be conducted with some regularity. 

And because you want to ensure there is equity across your current staff and the jobs you’re looking to fill, a pay equity audit can help you understand where gaps exist, where they’re being addressed, and where you need to focus your efforts to prevent future pay discrepancies.

Step 4: Incorporate equity into your pay ranges

Once you’ve made pay equity auditing a part of your compensation policy, you need to act on the findings discovered. If pay disparities exist for any unexplained business reason, correct them and ensure your established internal pay ranges are reflective of any pay changes you make. This will prevent wage compression from occurring down the line. 

These established, verified, and equitable salary ranges will account for your current staff and how much they earn. With this information clearly documented and shared, your hiring staff will be able to recruit with confidence. 

Step 5: Continuously monitor pay equity 

Pay is dynamic. Given the current state of the competitive labor market, discussions around compensation are charting into new territories. Organizations looking to retain their workforce, while also bringing in new candidates, must continuously monitor their pay equity profile. 

As you hire new employees, you need to be confident that your compensation practices are equitable.

Tools like the Equal Pay Estimator can help organizations strategically develop pay ranges that adhere to the external labor market, as well as the internally established ranges. With software like this, you can confidently post salary ranges in your job listings so that they’re both competitive and equitable. 

The Equal Pay Estimator solves wage compression because it takes into consideration your established pay ranges across all departments and lays the data against the evolving external market data. The result? An equitable pay range – every time. 

To see how PayParity and the Equal Pay Estimator can help you retain talent and minimize wage compression, book a meeting with one of our expert pay equity consultants.

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Organizations that conduct a pay equity audit must communicate their progress and achievement along the way. To help you faciliate discussions around compensation, we created the Pay Equity Communications Planner.