On Employee Compensation – note #2, NewCo Compensation Principles

Thought experiment: if you were running a company of your own, starting from scratch, what principles would you adopt with respect to the employee compensation system? Here are mine:

* Simplicity. The compensation system must be easy to understand and implement, thus avoiding employee confusion and lengthy, error-prone decision-making processes.
* Fairness. Each employee should be compensated fairly and justly relative to all other employees and relative to the market as a whole.
* Meritocracy. Each employee should be compensated in proportion to their net contribution towards the key success drivers of the business. “Net” includes both direct individual contributions and collaborations with others, with a weighting appropriate to the business and nature of work.

* Transparency. Compensation outcomes such as salaries, promotions, and so on should be fully transparent. Doing so encourages fair, meritocratic compensation decisions by forcing the outcomes into public view.
* Egalitarianism. The pay differential between the lowest-paid employee and the highest-paid employee should correspond directly to their expected relative contribution to company success. For instance, if the highest-paid employee is expected to contribute roughly 10x more value to the company than the lowest-paid employee, their total compensation package should be roughly 10x that of the lowest-paid employee’s package.
* Democracy. Every employee is responsible for influencing the coaching, future job responsibilities, and compensation of other employees they work with by providing performance feedback on a continuous stream basis, and merit assessments periodically. The performance feedback drives coaching and job responsibilities. The merit assessments, summed up, define compensation increments. Management is an equally weighted participant in this process… “one man one vote”.

* Transparency is a key check and balance that ensures the other principles are enacted. Without this, it is much easier to game any system, and much harder to generate mutual trust.
* As a basic premise I want to encourage collaboration and push as much autonomy and control as possible to individual employees throughout the organization. Hence the democratic principle.
* Yes I really am saying that employees should decide how much incremental compensation coworkers get based on a democratic process. I believe a decision market may be an appropriate mechanism for implementing this principle (see definition or read Wisdom of Crowds). I can see risks in it. I’d like to try this experiment in any case, and hear about any others who have tried it.
* Yes I really am saying that employees should have a say on future job responsibilities of their coworkers. This is especially true for people in leadership positions; they should essentially be voted in and out of office on a regular basis. One risk here is that a leader loses their job because they have to make an unpopular decision. This is an education issue… smart people should acknowledge that unpopular decisions are sometimes part of a leader’s responsibilities, and competent leaders can convince others that a correct yet unpopular decision is the right thing to do.
* Egalitarianism runs against the trend of extreme differential pay commonly found in stock-driven companies, where executives may earn hundreds of times what lower-paid employees do. It is a natural corollary to the principle of fairness. Depending on the mechanisms used to implement the compensation system, egalitarianism may be an emergent property rather than something you have to enforce through artificial constraints.
* The meritocracy principle doesn’t prescribe whether rewards should be weighted more towards group results or individual employee results. The appropriate weighting is a business-specific decision. Both attributes should have some weight, though… otherwise you get the “lone hero” syndrome at one end of the spectrum, or pure communism at the other.
* Performance feedback and coaching should be ongoing (realtime), driven by the stream of 360-degree input from customers and coworkers. This process is distinct from merit / compensation assessment, but it’s a vital input in that it forces people to make their thoughts on performance explicit. Once that is done, coaching becomes easy, and forming an opinion of merit and compensation becomes easy.
* For very small companies, the simplicity principle trumps everything else. That’s why partnerships make so much sense… just split compensation according to some fixed rules until there are enough employees to justify a more compex system.

6 responses to “On Employee Compensation – note #2, NewCo Compensation Principles

  1. hmm.. I beleive its subjective and perspective. If you found a company you have to decide if it’s going to be funded. Money people are predators and want AS MUCH AS POSSIBLE which means control. Founders want control. It’s all about shares. Founders without control are expendible and frequently are.

    Compensation has to be based on metrics for compliance reasons now (Sarbines Ox) so comparables are used. A CEO worth 100X a mail clerk.. um yeah. If the Mail clerk goes home and quits the company will barely notice. The CEO gets nailed with a DUI and company stock plummets. If you recruit a mail clerk, they know what their job is worth anywhere else. If you recruit a VP , they sure as hell know what their peers are getting.

    I think the current system is broken, I agree with you. Not sure that bringing the high low is the cure. Some people are professional employees. Others arent.

    Cheers.. GREAT BLOG DUDE

    Victoria BC

  2. Hi Rob. I think we agree on most points. Further thoughts / clarification:

    1. In accordance with the Meritocracy principle, compensation should include a risk premium. Specifically, founders and other early-joiners should get a higher potential reward — generally done in the form of equity / ownership — than late-joiners. After all, early hires are expected to contribute much more than most later hires. They are forming the company strategy and structure and culture, and doing that in the face of large opportunity cost.

    2. “Bringing the high low”. This is not my aim. I am instead saying one must form an explicit philosophy on how egalitarian to be. As you suggest, the tough part about the CEO / mail clerk example is setting their baseline compensation ratio (10x? 100x?) and the potential for upside e.g. incentive pay. Far be it from me to prescribe ratios. But common sense says if the numbers get sorely out of whack with people’s sense of fairness, you end up with a sick work environment where a rich few act entitled and the poor masses become disenchanted because they see insufficient upside. I don’t want to work in a system rigged that way.

    3. Money people / funding can muddle things up. My funding priorities: sweat equity first; angels second; venture capital third and only if truly required and appropriate to what the biz can generate.

    Thanks for the thoughtful comments.


  3. Then we agree essentially on point 1&3. I guess fairness is where the potholes are found.

    The problem is really with corporate longevity. Companies are like nations, in the beginning it’s all “egalitarian”, everyone helping each other take in the crops, make decisions etc etc. Then over time, specialized experts are brought in to manage. They didn’t help found the country but they now run it. Now their only compensation is money and power. Then there’s a whole class of people with money and power and the bulk of the citizens are not included. I think you are alluding to a corporate aristocracy. And like the problem with feudalism, there’s a revolution waiting to happen. I agree. I am just not sure what the true answer is. You can do profit sharing by ratio but there are employees who ride the real winners (how do you prevent remoras?). There are top performers who are Grade A morons and jerks.

    I think you need to break a company into three layers for comp purposes. Theres the “workers” and these folks want security above all else. Wage workers basically. Same as a departments store, mill or tech shop. They want a job, security, benefits and vacation time. They expect to earn more this year than last year. They expect that they will earn more than the “new guy”. They do the bulk of the work. But, they are close to a commodity. So there should be an industry wide scale for their positions and a smart company has a proactive HR department that ensures all levels are in the middle to top range and the day to day needs are met. If there’s a stress bonus for new projects etc that rewards by incident (new project, everyone on it works like dogs for 5 weeks and they get a bonus and recognition). But these people are unlikely to want to be managment or entrepreneurs. To find the ones that do, that’s an HR function (find the gold!).

    Middle Mgt: These are the ones who want more money for more responsibility. They want/like to tell others what to do, like to lead more than level one but still want the steady paycheqe and benefits. Basically a “worker with perks”. This should be where you see direct fairness principles applied. These are the people who have day to day contact with the “worker”. If there’s a conflict, poisoned atmostphere it’s likely to be at this level. So Middle Mgmt needs training (with more comp) and education to be better managers. They understand more of the gameplan and have more hand in how it happens. So IMHO this is the layer where there’s a direct ratio: 1 Manager with 10 Employees = 200% of employee wage. VP with 10 Mangers should get 200% of middle manager salary.

    Now there’s Mount Olympus. These folks can be the Versaille or the Polit Bureau or the Roman Senate. You find the people who are public lightning rods, the board whipping boys, the Jerks, the golden boys/girls and foudners. There is huge risk for being there and making the calls but also there’s prestiege. The Board can be a patsy or a micromanaging hell. You don’t have traditional protection of the employee, nobody cares if you get canned for a dumb decision. Personality can determine your job stability. Back stabbing is lethal not a “sport”. Bad decisions can lead to jail time. Responsibility to shareholder is legal priority (not god, country or rule of law). Air is thin up here, and chance to go up is not good. Most top people are brought in , not grown there. There’s little contact with actual workers and disconnect occurs. Theres different motivations and conflicting reasons for doing things. Some management decisions may be good from a shareholder point of view but make no corporate sense whatsoever. Other decisions are arrogant and mean but the board ordered it. Senior execs are expected to fall on their swords. More access to the cookie jar means more cookies get taken. Hanging out with rich people makes you want to be richer than them. Job satisfaction is less tangible in a 9-5 context. Was it a good year? What about next three months. Today?? Who cares about today.. what have you done lately?

    I think our corporations relfect our societal conflict between have more/have less. If a kid has more marbles than the other kids someone hates him. I HAVE NO CLUE how to make it permanently fixed. I do think a wise CEO worries about this though. Work was never intended to be a place where a person’s hopes and dreams and sense of self worth is maintained. Thats a white collar phenomenon. I guess we need to realise it’s just feudalism and there are lords, knights, bishops and serfs… how do you fix it without breaking it. How to break it and repair it without killing it or losing the good bits. Socialism isn’t inherintly bad, it’s just an ambition killer. Ambition is the desire to have more than someone else, do more, be more, appear to be more. It’s human. Why do it if not for your own benefit ?

    Sorry for the excessive lenghth.. It’s a VERY good and important topic.


  4. Tomi

    This can work! Check out the Fast Co article on employment practices at GE’s jet engine plant in Durham, NC

    Everyone knows how much money everyone else makes, because employees are paid according to his or her skill.

  5. Deb

    Love this subject matter because i’m always thinking working with 2 large companies that there are definitely more efficient ways of doing things. One thing that stood out for me in a course in HR that i took was that it wasn’t really $$ that motivated employees and kept them interested over the long term. I think your point on the 360 degree feedback and relevant rewards and recognition of an employees good work is very powerful. Companies that break out of the traditional mould of recognizing the work of their employees and motivating teams to high performance will have much greater success IMO – than those that focus exclusively on the monetary aspect.

  6. Pingback: My Own Pirate Radio » Blog Archive » On employee compensation – note #3, Democracy in Action


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