Pay employees what they’re worth not what they’ll accept

This week I was faced with a situation where a potential hire felt burned by their past compensation experience. They found out they were being substantially underpaid compared to their peers even though they were acknowledged as one of the highest performing employees. When they joined the previous company, this individual had accepted an offer that was much lower than what others were willing to accept, and that set them on a substantially lower compensation trajectory.

This raises an important question that all companies must wrestle with: how should you compensate your employees? At one extreme, you can pay employees the lowest possible amount they are willing to accept. On the other, you can pay employees the maximum amount you are able to pay someone with their skills. Let’s consider the pros and cons of these two approaches.

At first, paying employees the minimum they’re willing to accept appears to be the clear winner from an economic standpoint. However, that doesn’t hold up under closer scrutiny. In order to work, it relies on employee compensation remaining strictly confidential. Compensation will likely vary widely between employees with similar skill sets because they will each have different minimum acceptable amounts. If this disparity becomes widespread knowledge you risk a team crisis, particularly among top performers who discover that they’re paid less than their peers. Anyone who has worked in industry for more than a few of years knows that compensation is anything but confidential. People talk, and with resources like becoming more popular it’s easier than ever to get a sense for what your peers are being paid. In addition, your best employees usually receive a steady stream of recruiting offers from other companies. If you undervalue them by only paying what they’re willing to accept you run a higher risk of losing them to someone who is willing to compensate them at a level commensurate with their abilities. Aside from risking employee morale and heightened attrition, I believe this style of compensation also speaks negatively to the type of company culture you’re trying to build. It makes it crystal clear that you value the bottom line far more than any individual, and that’s a great way to discourage loyalty and create a cut-throat self-centered organization.

Alternatively, paying employees the maximum amount you’re willing to offer someone of their skills is costly from a cash flow perspective. It is highly likely that many of your employees would have accepted more conservative offers. However, this has the potential to create a company culture that affords a level of productivity and loyalty great enough to offset the increased compensation costs. Instead of worrying about keeping everyone’s compensation under wraps, you can more openly discuss compensation and what it will take to move up to the next pay band. When making an offer, you can be clear about what you consider market rate for the position and how you’re adjusting it up or down by some amount due to the applicant’s specific skills and experiences. Employees will feel like their compensation is fair, they are properly valued, and there is a clear path to increased compensation. It is also less likely that outside recruiters will be able to offer dramatically higher compensation. This level of transparency and fairness does an excellent job of fostering employee loyalty and making them feel like they work for a company that cares about them as an individual. One thing to note is that this style of compensation is still viable in an early-stage startup that does not have the cash to pay market-rate salaries. In these cases, everyone should understand that salaries across the board are lower than market rate, but the lower cash compensation is offset by greater equity and potential for rapid career development. It should also be made clear that salaries will be adjusted towards market standards upon reaching profitability or taking in significant additional funding.

As I’m sure you’ve gleaned by now, I lean heavily towards the later style of compensation. I do not believe in overcompensating employees (that leads to its own unique set of problems), but I have seen first-hand that undervaluing employees is short-sighted and leads to serious long-term issues. Furthermore, if you don’t think someone is valuable enough to compensate fairly, then you probably shouldn’t bother hiring them in the first place.