How to set compensation using commonsense principles

https://erikbern.com/2020/06/08/how-to-set-compensation-using-commonsense-principles.html

Principle 1: align with market Two quantities are important benchmarks for someone’s salary:

• Market rate: if this person started here today, what would we have to pay to get them?
• Replacement cost: how much are we willing to pay in order to get this person to stay?

If your compensations are aligned with market, then no one should be below market range (give them a raise before they quit), and no one should be above replacement cost (then they should be replaced). Ideally pretty few should be above market range but below replacement cost (the purple zone), although I consider that zone a bit of a special “insurance card” you can buy, like if someone on your team has some deep domain knowledge that’s absolutely crucial right now so you don’t have time to hire a replacement and train them.

Principle 2: create consistency

The only solution to all of this, is to make sure salaries are consistent. A useful Litmus test is: if all salaries were made fully transparent, would people be upset? If so, you might have an inconsistency problem.

I kind of glossed over what “consistency” exactly means here, but just to clarify: if person A is more productive than person B, then A should have a higher salary than B.

Sign-on bonus But from a company’s point of view, it offers a critical advantage: you can retain salary consistency, while still being market competitive. This applies especially in cases where there’s significant uncertainty about a candidate. A $150,000 salary with a $20,000 sign-on bonus is essentially like a salary that drops from $170,000 to $150,000 the second year. If the person is awesome, you can always raise the salary back. If they aren’t, then you keep them at their new “lower” salary, and keep your team’s compensation consistent.

Total compensation Here’s my opinionated view on how to do this:

• Base salary is obviously part of it.
• Equity is a part of it, and divided by the vesting time, and using the original value of the grant, not the present value. And for options, subtract the strike price. I often also think it’s worth putting a small discount (10-30%) on the value to compensate employees for the risk.
• Bonus should only be a part of it if it’s the “roughly guaranteed” type of bonus.