Compensation programs are implemented as a means to link pay to performance and results. It is common for higher pay to be offered to those employees who perform better than others or who are perceived to have the most positive impact on an organization. However, salary compression may lead to systematic inequities for a group of positions or for positions across an entire organization. Morale issues result when employee capability is tied to professional maturity but changes in salary structures do not mirror increases in that maturity. The morale issues are compounded when such issues persist over an extended period of time.
Salary compression can occur for a number of reasons. For example, an employer may offer similar or higher starting salaries to new hires with long-term potential than salaries paid to experienced employees. This situation is compounded if experienced employees receive merit increases that fail to keep pace with employment market conditions for positions that are high in demand. This situation is further exacerbated if similar increases are offered to both high and low-performing employees. Salary compression may also occur if a company hires and pays a premium salary to new employees who have a specific expertise that is not possessed by existing employees.
Productive employees whose salaries are compressed are likely to interpret the situation as the organization's lack of respect for their tenure, experience and contribution to the company. As a result, the employees may search for employment elsewhere. Alternatively, if the employee remains with the organization, he may resent the new employees and fail to train or otherwise cooperate with them.
The existence of formal hiring rates that are evaluated on an ongoing basis will best ensure a similarity between the offers extended to new hires and the salaries of current employees. Benchmarking salary rates to market rates also ensures that pay scales are competitive with those of other organizations.
One counter to salary compression is the linkage of the salary administration program to the employment market. One-time adjustments or periodic adjustments to the salaries of existing employees can also be used. Alternatively, lump-sum merit increases can be paid to current employees rather than offering base salary increases. To preclude salary compression, hiring bonuses rather than higher salaries can be offered to new employees. In addition, less experienced employees can be hired at a lesser pay grade and then trained to avoid the possibility that higher starting salaries will contribute to an existing problem of salary compression.