What is a compensation policy?

A compensation policy is a combination of the philosophy and practices a company adopts when determining employees' pay, rewards, and benefits, which is critical given that compensation can account for up to 70 percent of total costs for an organization. Every company will have its own compensation policy, though you may find that certain industries have similar or comparable approaches to pay and benefits.

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While "compensation" primarily refers to salary, incentives like bonuses, commission, equity, allowances, and other types of perks are often referred to as "total compensation" and included in the company's policy.

Why do companies need a compensation policy?

So, why do companies need a compensation policy? It creates fairness and consistency in how you pay, reward, and provide benefits to your team—eliminating guesswork, potential legal issues, and negative employee health outcomes. One study found that women experiencing pay inequity were four times as likely to suffer from generalized anxiety.

For example, if 'Employee A' has a verbal agreement with their manager that their overtime rate is $25 an hour but 'Employee B' has an overtime rate of $20 an hour for the same work, this could be seen as an uneven or unfair pay discrepancy.

Additionally, compensation can be complex, tricky, and dependent on a number of variables. In fact, one survey found that most organizations were in the middle of redesigning compensation or had recently done so, and 64% expected to do so again within three years. That's why having guardrails and policies in place is important for any organization.

What does a compensation policy cover?

Here's the thing—a compensation policy isn't about dictating exact pay for everyone. Instead, it outlines your approach to compensation structure, total rewards, and legal requirements.

Additionally, a compensation policy may cover compensation review frequency, overtime guidelines, and severance policy.

Key components of an effective compensation policy

A strong compensation policy is more than just salary numbers. It's a clear document that explains your company's approach to total rewards. To ensure fairness and transparency, your policy should include several key components.

• Compensation philosophy: A brief statement explaining your company's values and goals around pay.

• Salary structure: This includes job levels and salary bands or ranges for different roles. It provides a consistent framework for pay decisions.

• Variable pay: Details on bonuses, commissions, or other incentive-based pay.

• Benefits and perks: An overview of non-salary compensation, such as health insurance, retirement plans, and wellness stipends. For private industry workers, these benefits costs accounted for 29.8 percent of total employer compensation costs in June 2025.

• Equity compensation: Guidelines on how stock options or other forms of equity are granted.

• Review process: Information on how and when compensation is reviewed, including performance-based raises and promotions.

How to create a compensation policy

Creating your first compensation policy? It can feel overwhelming, but breaking it into steps makes it totally manageable. The key is building something fair, competitive, and aligned with where your business is headed.

Here's a simple, step-by-step guide to get you started:

1. Define your philosophy: Start by deciding what you want your compensation to achieve. Is your goal to pay at the top of the market to attract the best talent? According to Gallup, 64% of employees name a significant increase in income or benefits as a critical factor in taking a new job.

2. Research the market: Understand what other companies in your industry and location are paying for similar roles. This helps you stay competitive, especially since research shows that nearly half of all employees are actively looking for a new job or watching for openings.

3. Establish job levels and salary bands: Group similar roles into levels and create a salary range for each level. This creates a clear path for career and salary growth.

4. Document everything: Write down all the components of your policy in a clear, easy-to-understand document. Avoid jargon and be transparent.

5. Communicate with your team: Share the policy with managers and employees. Explain how it works and answer any questions to build trust, as employees increasingly value transparency—one poll found that 56% of workers would support making their income publicly available.

Compensation policy best practices for global teams

Global teams bring unique challenges—what's competitive in New York might be below market in London, and compliance rules vary everywhere. The good news? A thoughtful approach keeps everyone engaged and fairly paid.

Here are a few best practices for global compensation:

• Localize your offers: Pay and benefits expectations vary widely across the globe. Tailor your compensation packages to meet local market rates and statutory requirements to stay competitive and compliant. Failing to do so can have significant consequences; in one case, a global audit found over 7,000 employees were being paid below the living wage across 37 different countries.

• Prioritize global fairness: While packages should be localized, the underlying principles of your policy should be consistent for everyone. This ensures fairness, no matter where an employee lives.

• Use a single source of truth: Managing compensation across multiple countries with spreadsheets is risky. A global employment platform helps you centralize data and ensure consistency.

• Communicate clearly: Be transparent about your global compensation strategy. Help your team understand how their pay is determined to build trust and reduce confusion.

Building fair compensation with Oyster

A well-defined compensation policy is the foundation for building a fair, equitable, and motivated global team. It removes guesswork, ensures consistency, and shows your employees that you value their contributions. By creating a transparent framework, you can attract top talent and grow your business with confidence.

Oyster's global employment platform simplifies the complexities of international pay. We help you design competitive, localized rewards and manage payroll compliantly across borders. Ready to build a global team the right way? Start hiring globally.

FAQs

What are the three types of compensation?

The three types are direct compensation (salary, wages, bonuses), indirect compensation (health insurance, retirement plans), and non-monetary compensation (flexible schedules, development opportunities).

How long should a compensation policy be?

There's no set length—focus on clarity over word count. Most small to mid-sized companies need just a few pages to cover the essentials.

What is an example of a compensation plan?

A typical example is base salary plus commission—like a sales rep earning $60,000 annually plus 10% commission on sales. This gives income stability with performance incentives.

Disclaimer: This article and all information in it is provided for general informational purposes only. It does not, and is not intended to, constitute legal or tax advice. You should consult with a qualified legal or tax professional for advice regarding any legal or tax matter and prior to acting (or refraining from acting) on the basis of any information provided on this website.