Rewarding Loyalty: Maintaining Equity and Avoiding Pay Compression

Picture this: your experienced, top-performing employee has been working for your company for years. They’ve made an impact in their department and have been rewarded with promotions along the way. They’re really shaping up to be a leader in the field, and they’ve become an integral part of the team.

One day, they are chatting with the team and learn a new hire doing the exact same job is making the same (or more) money to do it. Do you think that leaves them feeling appreciated, supported, and energized to keep working hard? Probably not.

Pay compression most commonly occurs when long-term employees are paid close to or the same as recent hires and is a major driver of low morale, high turnover (especially of high-value veterans), and internal resentment. When designing a compensation philosophy, nobody aims to create a negative environment. However, when internal equity isn’t maintained and pay compression creeps in, employees can become disillusioned and decide to find a new position that they feel values their skillset appropriately. Employee turnover is costly for time, effort, and money — think of the knowledge gaps created if your high-performing, loyal employee moves on.

To maintain equity and avoid pay compression, there are foundational elements and routine practices to implement into your compensation strategy. 

What Causes Pay Compression?

When creating equitable pay practices, you have to understand how pay compression happens and be able to spot it quickly. Pay compression doesn’t become an issue with one mis-priced job, it usually spreads across your program slowly and is created by multiple compounding internal and external factors. The following factors, if they go unchecked, often contribute to pay compression:

1. Market shifts: Rapidly increasing starting salaries in tight labor markets can lead to an imbalance between salaries of new and existing employees.
2. Minimum wage changes: Mandated increases at the bottom of the pay scale can “crunch” up the space between different levels of employee salaries.
3. Inconsistent adjustments: A lack of regular, merit, or market-based pay reviews for existing employees can create salaries that are out-paced by the market.

As your team grows, new positions can be added to headcount plans quickly, and that kind of hiring hustle can cause teams to focus on what’s needed to entice the right new hire rather than evaluate how this new hire fits into an existing wage structure. While strategically pricing salaries for new hires is a huge part of maintaining equity, you also have to evaluate how you’re paying your current employees. Budget constraints can lead to minimal annual raises for incumbents, while market-driven salaries for new hires surge past them. You can’t control the market, and rapid wage inflation or high competition for talent forces higher starting salaries for new employees, but you can control how you work to help your current employee salaries keep up with the ebbs and flows of the market.

4 Steps for Maintaining Equity and Preventing Pay Compression

1. Establish and Audit Market-Driven Salary Bands

If you’re cleaning up equity issues, the place to start is often the most messy: salary bands. Pay compression often stems from salary bands that haven’t been updated to match the market or from salaries being set outside of the set ranges. Start by digging into what’s happening in the market, then define clear minimum, midpoint, and maximum ranges (bands) for every role based on reliable external market data.

Once you set salary bands, take time to evaluate any existing equity issues and make any necessary adjustments to rectify them. These salary bands need to be audited at least annually to ensure they reflect current market rates and maintain internal equity. During these maintenance audits, it’s also important to confirm that the maximum of the entry-level band does not significantly overlap with the minimum of the next-highest band so you offer clear differentials for employee promotions and growth.

2. Implement Structured Growth Plans

Once you narrow your salary bands, the next step is to implement a structured growth and merit plan. If you want to support your employees’ loyalty and contributions, it’s time to move beyond fixed-percentage annual raises. Linking pay increases directly to a combination of performance ratings, tenure/experience, and position within the salary band creates a more equitable approach and helps you avoid existing employees feeling a “crunch” when new hires enter the team with a competitive salary.

These merit plans are also not purely financial paths. While employee turnover can be attributed to financial reasons, a leading reason for regrettable turnover is a lack of growth opportunities. A strong job architecture is a necessity for defining career ladders and can also clear up confusion about how salary bands are applied to employees with different levels of experience. Outlining levels for each department  (like what differentiates a "Software Engineer I" from a "Software Engineer II") guarantees that moving up the ladder offers a significant pay bump and a change in responsibilities, reinforcing the value of tenure and skill growth.

3. Regularly, Holistically Evaluate Equity

If you’re putting the work into creating an equitable compensation program, you don’t want to watch that work go to waste due to a lack of maintenance. Conduct a formal, internal equity review (separate from the performance review cycle) every 18-24 months to catch any compression issues that have popped up. This is a great opportunity to identify long-term employees whose current pay falls below the midpoint of their tenure/skill level, especially relative to recent hires. It can help to dedicate a specific, ongoing budget line item (separate from the standard merit budget) for "Compression & Equity Adjustments,” so you can apply targeted, lump-sum adjustments to restore the internal pay differentials and recognize employees’ accumulated value.

4. Foster Transparency and Educate Managers

A commitment to equity and employee retention shouldn’t be a secret mission, and in many areas, pay transparency is now required by law. Transparency builds trust and reduces the speculation that often drives complaints about perceived pay inequities. Train managers to clearly communicate the company’s compensation philosophy — not specific salaries, but how pay decisions are made. Giving managers the tools and visibility (within policy constraints) to explain why an employee's pay falls where it does can also help ease conversations about where they’re headed in their career journey and what steps they need to take (skill acquisition, performance) to advance.

Pay compression is not an isolated event, instead it’s the result of falling behind on equity maintenance. Addressing equity requires commitment and should be viewed as a pillar of a strong compensation program. Ultimately, taking an equity-focused lens when evaluating your program leads to a foundational investment in your employees, transforming what could be a silent killer of morale into an engine that drives high performance, retention, and trust across your entire organization.