Pay Compression

What is pay compression?

Pay compression (also called salary compression) is a situation where the pay gap between employees of different experience levels or seniority narrows to an undesirable degree.

As a result, the pay difference between these groups of employees becomes smaller, or “compressed.” Pay compression can also occur when a company freezes or reduces pay for higher-paid employees while still giving raises to lower-paid employees.

What is the process of pay compression?

The process of pay compression can occur in a number of ways, depending on the company’s policies and practices. HBR’s pay compression research

Some common causes of pay compression include:

1. Across-the-board pay raises: A company may give all employees a pay raise, but the percentage increase may be larger for lower-paid employees than for higher-paid employees. This can lead to pay compression, as the difference in pay between the two groups becomes smaller.
2. Market adjustments: A company may adjust pay for certain jobs or levels based on market rates, but not make similar adjustments for other jobs or levels. This can also lead to pay compression, as the difference in pay between the two groups becomes smaller.
3. Mergers and acquisitions: When two companies merge, their pay scales may be combined, but not always in a way that preserves the difference in pay between employees with similar qualifications and experience. This can lead to pay compression.
4. Freezing or reducing pay for higher-paid employees: This can happen when a company is going through a difficult financial period and decides to freeze or reduce pay for higher-paid employees, but not for lower-paid employees.
5. Performance-based pay: A company may have a performance based pay system that rewards employees who meet or exceed certain performance targets. However, if the criteria for these rewards are not clearly defined, it can lead to pay compression as employees may be rewarded based on subjective criteria.

What are the impacts of pay compression?

Pay compression can have a number of negative impacts on a company, including: SHRM’s pay compression guidance

1. Morale: Pay compression can create dissatisfaction among employees, particularly those who feel that they are not being fairly compensated for their qualifications, skills, and experience. This can lead to decreased morale and engagement, which can negatively impact productivity and retention.
2. Retention: This can make it difficult for a company to retain its best talent, as employees may seek out opportunities with other companies that offer more competitive pay.
3. Recruitment: This can make it difficult for a company to attract new talent, as potential candidates may choose to work for other companies that offer more competitive pay.
4. Inequities: This can lead to inequities in pay between employees with similar qualifications, skills, and experience, which can be perceived as unfair and lead to dissatisfaction.
5. Productivity: This can lead to decreased productivity, as employees may feel that their work is not valued and may not be motivated to put in extra effort.
6. Legal issues: This can lead to legal issues if it is determined that the company is not complying with labor laws and pay equity requirements.
7. Brand reputation: This can harm the company’s reputation as a fair and equitable employer, which can negatively impact its ability to attract and retain top talent.

Proactively managing pay compression retains experienced employees and ensures compensation structures remain fair and competitive for attracting top talent. Organizations using pre-employment assessments ensure every hire is grounded in verified skills. A data-driven hiring plan reduces mis-hire risk, while strong talent acquisition practices focused on skills-based hiring help organizations attract and retain top talent.

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