How Does Compensation Affect Employee Retention?

by Ruth Mayhew; Updated September 26, 2017

Compensation can have a direct impact on employee retention. While employers may use employee incentives and monetary rewards to retain employees, there are ways to complement compensation that have a much greater impact. Based on the type of compensation, along with the terms and conditions of an employee compensation package, an employer can boost employee retention.

Employee Retention

Employee retention refers to the number or percentage of employees your organization retains. The term retention is often used in discussions about employee turnover. The differences between retention and turnover are subtly related; however, retention is more about improving satisfaction of current employees by providing challenges, development opportunities and incentives such as retention bonuses and compensation that encourages your most talented employees to stay with the company. Turnover, on the other hand, is inevitable within any organization. Turnover occurs both involuntarily and voluntarily for a number of reasons. Attempts to reverse turnover using retention strategy that includes compensation is ill-advised, not to mention counterproductive.

Initial Compensation Structure

Employers develop an initial compensation structure that complements various steps of workforce planning. Workforce planning consists of creating a formula for the types of skills, expertise and concentration of workers that are necessary to achieve the company's goals. Once the organization completes its workforce planning steps, the next step is creating a competitive, yet feasible, compensation structure. Too often, companies give little consideration to reevaluating compensation to ensure it addresses future business needs, such as employee development, inflation, employment trends and succession planning.

Employee Retention

Employees looking voluntarily to make a change want to continue their career with a company that offers promotion and development opportunities, a collegial work environment and a leadership team that's openly appreciative of its human capital. Compensation and benefits may be important factors in the decision to look for employment elsewhere; however, many reports indicate compensation is low on the list of priorities in looking for another position. Employees have an intrinsic need for respect, motivation and challenging work, which are compelling reasons for seeking employment elsewhere. Employers who consider compensation as part of the strategy for employee retention are headed in the right direction, but are looking at just one half of the equation. Compensation coupled with better opportunities to develop employee skills is a more complete way of formulating an effective retention strategy.

Tying Compensation to Retention

One of the most effective ways compensation can have a positive impact on employee retention is to construct an employee development plan that promises employees career track opportunities with the company. Being on an upward career track should come with corresponding salary and merit increases. In addition, performance-based bonuses motivate employees in terms of aligning their individual goals with company goals. Implementing incentives such as stock options, profit sharing and spot rewards are other ways compensation affects retention. These forms of compensation demonstrate how critical employee performance is to the organization's overall profitability. Spot rewards are usually not as lucrative; however, they provide immediate recognition, reward and compensation when company leadership observes an employee performing superior work. Appreciation is key to employee retention, and if compensation is a part of recognition, then compensation is likely to increase employee retention.

About the Author

Ruth Mayhew has been writing since the mid-1980s, and she has been an HR subject matter expert since 1995. Her work appears in "The Multi-Generational Workforce in the Health Care Industry," and she has been cited in numerous publications, including journals and textbooks that focus on human resources management practices. She holds a Master of Arts in sociology from the University of Missouri-Kansas City. Ruth resides in the nation's capital, Washington, D.C.