How people are paid is always a top priority for companies, especially with recent macroeconomic events, but some companies are still reluctant to invest in a Compensation function. This is due, at least in part, to the view of compensation expertise as a “nice to have” rather than a “must have,” a view bolstered by the assumption that a compensation function is redundant and something that can or should be done by other departments, usually Finance or Accounting. Can it be done by other capable departments? Yes, but it shouldn’t be.

What compensation isn’t: Finance, and that’s good

Mercer’s internal research indicates that there is a 30:1 ratio of the general employee population to those employees who specialize in Finance. For HR, the ratio is 90:1. ¹ This means the ratio for compensation professionals is likely in the thousands, but that assumes the company has anyone dedicated to the compensation function at all.

According to Payscale’s most recent Compensation Best Practices Report , “only 44 percent [of companies] have a person or team dedicated to compensation.” Interestingly enough, top performing companies have a higher percentage (48%) than do their lower performing counterparts (33%). This leads them to conclude that “[o]ne of the biggest differentiators between top performing organizations and non-top performing organizations is the presence of a person or team dedication (sic) to compensation.”

Similar, but different

It is unsurprising, then, that compensation programs are designed and administered by one of two groups or departments: Finance or Compensation. If there is not a Compensation team, then it is almost always administered by those in Finance. The reason for this is fairly simple: the administration and design of compensation involves money and calculation. Finance is a group within an organization that is good with both. But that is where the similarity ends.

Finance, generally speaking, is about understanding financial records and creating a plan and recommendation on how to spend in the future. Compensation decisions are intended to be more interdisciplinary, reviewing pay decisions in the light of such factors as tenure and performance considerations, benefit costs, engagement results, talent pipeline and talent acquisition success, skills needs, and turnover and retention implications. This isn’t to say Finance is blind to or doesn’t consider the needs or impacts of employees; rather, that compensation is closer to those needs and impacts, both intellectually and oftentimes in proximity literally, and so better suited to design and administer the structures and programs that govern them. Compensation professionals are in the rewards space, which is in the human resource space — both are areas that are closer to considerations regarding individual employees. Finance’s proximity to these resources is more distant, often considering aggregated cost or forecasted cost with less attention to specific talent needs or impacts.

Finance, in short, deals with finish-line monies and aggregated dollars to determine financial health. Compensation, on the other hand, deals with livelihood monies, the investments and costs related to the employee population, which is likely to have the largest impact on the finish-line monies, not just from a cost perspective — because most companies’ largest cost is their workforce — but from a performance perspective, in that an engaged and properly motivated workforce drives productivity.

Difference in action

A common example that displays the difference between the two approaches of Finance and Compensation is with bonus plans. When a plan is designed and/or administered by Finance, the bonus plan is typically focused on the company’s financial success. There are two issues that usually come up. The first is the line-of-sight while the second is metric dilution.

Line-of-sight refers to how much influence the employees have over the results of the actual metric being measured. Metric dilution refers to the overburdening of a plan with far too many metrics — an oftentimes unintentional tactic to make up for weaker management. Overly specific compensation plans with more than the best practice number of metrics might allow the company to track more accurately the specific success or failure of certain products or areas, but it confuses and often discourages or overwhelms those employees it is intended to motivate. This is not to say that all plans must remain relatively simple; but rather that the intention behind the design of the plan should be first and foremost the incentivizing of the employee. Both of these are avoidable if the plans are tied closely enough to the correct employee populations — a regular and ongoing task for compensation professionals, along with the determination of the incentive plans administrative feasibility.

What Compensation is: A signal and risk hedge

One of the quickest and most definitive ways to signal to current and future talent that you are serious about the long-term health and success of the company and its employees is to have a well-supported and active Compensation team that has in place and adheres to a living compensation philosophy. The message that is sent is that your company cares about getting pay correct for both the company and the employee because leadership has put in place the team, tools, and direction to invest in employees and that investment directly relates to expected outcomes.

In addition to signaling, the company is also de-risking by having an articulated pay strategy and execution model that can be adjusted if something unexpected or fast-moving happens, like an acquisition, shifting economic conditions, or even a global pandemic. By already having a team and strategy in place, when the unexpected does occur, it is a matter of reviewing what has been done and making adjustments in a consistent manner that will not exacerbate the issue later.

It is true that even companies with Compensation teams struggle with unexpected challenges, but that’s not the question. Almost every company struggles in some way with unexpected challenges. The real question is that in the middle of a crisis, is it easier to build something from scratch or adjust and learn from something that already exists?

So, yes, you need a Compensation team. One that is supported by the appropriate investment from the company. Lauren Mason, a Mercer consultant, summarizes the situation well: “Labor shortages forced employers into reactive compensation changes in 2021 and 2022, but it will be important for employers to be more proactive and strategic about compensation increases in 2023, particularly in light of pay equity concerns and a declining economy.”

This observation is especially important because current compensation strategies tend to reward those who switch organizations, as companies, especially in a tighter labor market, are more willing to buy talent. This is concerning because Mercer research shows tenure is the primary human capital driver of operational and financial performance within an organization.

But this proactive approach also must be balanced with future-looking talent needs that companies will have based on plans for product development, market share acquisition, and other goals. For 2023 and beyond, companies will need a proactive compensation approach to anticipate talent needs and rewards for future growth while appropriately rewarding current, especially long-tenured, employees to ensure operational and financial success in the near term.

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¹ Internal Mercer report, “HR is still trapped in transactions,” 2022.