9 Common Compensation Issues: How to Identify and Fix Them
Balancing fairness, market competitiveness, and employee expectations is a constant challenge in compensation. Issues like pay compression, internal equity gaps, and rising costs create hurdles that organizations must address to maintain a motivated and loyal workforce.
Every organization, regardless of size, location, or industry, faces compensation issues. This means HR professionals must make tackling these challenges a top priority, especially since they are essential for winning the war on talent. In fact, 31% of employees say they are unhappy with their current compensation, and of those, 52% are likely to leave.
So, how can you address shifting employee expectations while staying aligned with industry standards, market trends, and new regulations? We’ll dive into all this and more. Let’s get started!
Contents
9 compensation issues examples
1. Rising inflation and cost of living
2. Internal equity
3. External equity
4. Perceived equity
5. Performance-based bonuses and incentive pay
6. Pay compression
7. Geographic pay differentials
8. Pay transparency laws
9. Competitive total rewards and benefits
Steps to identify and fix compensation issues
9 compensation issues examples
Understanding the nature of different compensation issues will help you proactively address them when they arise. Here’s an overview of some of the most common challenges organizations face today:
1. Rising inflation and cost of living
Many organizations have struggled to keep up with inflation. Rising costs have led to increased compensation budgets, with 71% of organizations planning to increase pay by at least 4%. However, many employees still struggle to make ends meet.
According to the Dayforce Living Wage Index, only 56% of full-time workers in the U.S. earn a living wage. Regularly reviewing compensation packages and incorporating cost-of-living adjustments (COLAs) can help ensure fair wages for employees.
2. Internal equity
Internal pay equity refers to compensating employees with skills or positions similar to those of an organization. Addressing internal pay inequities involves conducting regular pay audits and making necessary compensation adjustments. Staying up to date with pay equity laws is essential to comply with the latest regulations.
3. External equity
External equity refers to how an organization’s pay levels compare to those offered by competitors in the same industry or market. It involves assessing what other organizations are paying for similar roles. Considering broader market trends is essential when designing compensation structures. Offering pay below market rates can lead to challenges in attracting and retaining top talent, potentially impacting overall organizational success.
4. Perceived equity
How employees perceive pay equity in their organization can have significant effects on engagement and retention. Factors like rising inflation and cost of living can make them feel that they are being underpaid, even if their wages are competitive and in line with market or industry standards. This negative perception of pay equity can result in low motivation and frequent turnover.
HR tip
Develop a communication strategy to openly share the details behind your compensation philosophy, pay practices, and any other areas that affect individual compensation. Remember to be proactive, communicating key compensation decisions early so that employees are better informed about the rationale behind them. Patagonia exemplifies this approach by openly discussing living wages for factory workers.
5. Performance-based bonuses and incentive pay
If not well-managed, performance-based pay and other financial incentives can widen pay gaps between employees. In recent years, high executive bonuses have led to employee resentment and accusations of pay inequity. Some companies, like Ford Motor, are reevaluating managers’ bonuses, tying them to company performance, and lowering them if business goals are not met.
6. Pay compression
Pay compression occurs when the pay differences between employees with different skill levels, responsibilities, and experience become smaller in an organization. For example, a manager who has a slightly higher salary than their direct reports with less experience. Pay compression can happen for various reasons, such as labor market shifts, inconsistent salary adjustments, or higher starting salaries for new hires.
7. Geographic pay differentials
More than half of organizations (57%) have policies that adjust pay based on employees’ locations. These geographic pay differentials are typically influenced by factors such as the cost of living, local labor markets, employment laws, and other economic considerations. The growth of remote work has prompted many organizations to incorporate it into their geographic pay policies, with some differentiating compensation between remote and on-site employees.
Solve compensation challenges with strategic expertise
Compensation issues can significantly impact employee satisfaction, retention, and organizational success. Addressing pay equity, performance incentives, and market competitiveness requires a strategic approach grounded in data and best practices.
With AIHR’s Compensation & Benefits Certificate Program, you’ll gain the skills to tackle complex compensation challenges head-on. Learn to design equitable pay structures, conduct impactful audits, and align compensation strategies with business goals—ensuring your organization remains competitive while fostering employee trust and engagement.
8. Pay transparency laws
In recent years, more U.S. states have passed pay transparency laws, requiring employers to disclose compensation information such as salary ranges to job applicants and employees. This growing trend aims to promote fair pay and reduce discrimination. Adapting to these regulations may involve addressing pay equity gaps and making necessary compensation adjustments.
9. Competitive total rewards and benefits
Compensation isn’t just about base pay anymore—employees expect total rewards that go beyond a paycheck. The challenge lies in offering packages that feel competitive and resonate with what employees actually want: work-life balance, mental health support, professional growth opportunities, and meaningful perks. If these total rewards packages fall short, organizations risk losing talent to competitors who better align their offerings with modern expectations.
Striking the right balance between budget constraints and the evolving priorities of a diverse workforce can be tricky. Regularly reviewing and updating total rewards packages is essential to keep them relevant and effective, making this a core part of any compensation strategy.
Steps to identify and fix compensation issues
All of the compensation issues above require a proactive and strategic approach. Here are some practical steps you can take to address these challenges.
Reevaluate your organization’s compensation philosophy
A clear and well-defined compensation philosophy serves as a foundation for designing effective pay structures, managing compensation and benefits programs, crafting competitive packages for new hires, and guiding managers in retaining top talent. It should clearly document your organization’s values and the reasoning behind its compensation decisions while remaining flexible enough to adapt to evolving market trends, industry standards, and employee expectations.
Sharing a well-designed compensation philosophy, as Buffer does, can extend beyond internal communications. Highlighting it on your career site, job postings, or social media can attract potential candidates and showcase your commitment to fair and transparent practices.
When developing your compensation philosophy, clearly define the strategic people objectives it aims to support. For instance, if your goal is to attract scarce talent, the philosophy must prioritize market competitiveness. If retention is the focus, it should be carefully aligned with employees’ specific needs and designed to address them effectively.
Research the market
Leverage resources like salary surveys, online databases, and government labor statistics to determine current salary rates and understand how your organization compares. Platforms such as Payscale, Salary.com, LinkedIn Salary, Glassdoor, and the U.S. Bureau of Labor Statistics (BLS) are particularly valuable.
Remember to research any available salary and benefits information from your competitors’ job postings and career pages. If your budget permits, consider engaging consulting firms like Mercer, Willis Towers Watson, or Aon for a more tailored approach.
However, benchmarking against external competitors is just one part of the equation. As our AIHR Subject Matter Expert Dr Marna van der Merwe notes, “It is tempting to only benchmark against external competitors. While market comparisons are important, it is equally important to understand employees’ needs, expectations, and experiences. Employees often don’t leave because their compensation is less competitive; more frequently, it’s the mismatch between what they expect and what the organization actually delivers that drives them away.”
Keeping an internal perspective alongside market data ensures your approach is both competitive and aligned with your workforce’s unique context.
Conduct a pay equity analysis
Paying employees fairly is not only a legal requirement but also essential to attracting and retaining top talent. Conduct a pay equity analysis at least once a year to determine any pay disparities in your organization, focusing on any gaps among employees with similar skills, responsibilities, and job complexity.
Stay up-to-date on any changes to local labor laws and regulations, such as the recent California law requiring the reporting of pay data to the Civil Rights Department. To gain further insights into best practices in pay equity, consider reviewing annual studies from companies like Bank of America and Salesforce.
Track compensation metrics
Compensation metrics are essential because they help evaluate how well compensation practices align with your organization’s overall goals. Track metrics like compa ratio, salary range penetration, and market competitiveness. Automated dashboards can greatly streamline this process on a quarterly basis, helping you identify trends, spot issues early, and make timely adjustments. For a quick reference to key compensation metrics, download our Compensation Metrics Cheat Sheet and gain valuable insights to optimize your pay strategies.
Consider competency-based pay
Competency-based pay is growing in popularity. This pay arrangement aims to compensate employees based on their skills, knowledge, and capabilities – rather than their job title or tenure. Adopting a competency-based structure can help you address pay equity issues by providing similar pay for workers with certain skills and knowledge.
Another benefit of competency-based pay is the increased transparency into different compensation levels. Employees will better understand what they can earn and what they need to do to reach the next salary level. This skills-based approach to compensation can improve employee motivation, engagement, and retention.
Conduct annual compensation audits
Regularly reviewing your compensation structure, benefits, and bonus distributions is essential to maintaining fair and competitive pay practices. For most organizations, annual audits are sufficient, while larger organizations may benefit from semi-annual reviews. These audits help identify compliance issues, address internal equity gaps, and ensure alignment with your compensation philosophy and market benchmarks.
Amazon provides a strong example of this practice, using annual reviews to maintain competitive and industry-leading compensation. Their latest review resulted in increased pay and benefits for front-line fulfillment and transportation employees.
Utilize technology
Consider compensation management software or a Human Resource Information System (HRIS) to streamline compensation processes. These technology solutions can provide:
- Better accuracy in payroll and benefits calculations and distributions
- Real-time data analytics and reporting
- Centralized storage and management of employee compensation data
- Greater compliance with pay equity laws or other compensation problems
- Workflow automation for compensation audits.
Ensure legal compliance across states
Navigating compensation compliance can be challenging, especially with varying and frequently changing employment laws across states. Organizations operating in multiple locations must stay informed about local, state, and federal regulations, particularly regarding minimum wage, overtime, pay equity, and pay transparency laws.
If you work in a large company, you probably already have a legal team and advisors that will support you with this. If you are a smaller team, you should hire experts or involve consultants to ensure everything is in order.
HR tip
Create a compliance calendar that includes key deadlines for local, state, and federal reporting requirements and legal updates across relevant states. This tool can help you prepare and quickly adapt to regulatory changes.
A look forward
Addressing future compensation challenges requires a forward-thinking approach that emphasizes flexibility and adapts to evolving market trends, employee expectations, and potential disruptions. This may include implementing innovative pay models, leveraging technology and AI, and prioritizing transparency. These efforts can create a compensation system designed to meet the needs of a dynamic workforce.
Learn more
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