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Identify and Reduce Noise in Compensation Decisions


Progressive employers want frontline managers to be heavily involved in compensation recommendations and decisions for their team members. After all, frontline managers know better than anyone who the top performers are in each department.   

For most companies, frontline managers directly supervise around 80% of the total workforce.  These are the people who should decide about salary increases, promotions and bonus payouts. Right?  

HR and compensation professionals often call this “manager discretion.” Give managers a pool of money, then let them decide how to properly distribute the pool using their own discretion.   Let managers decide how to reward each member of their team based on some guidance about how to value contributions toward the success of the organization — and maybe some metrics based on financial or operational results. Sounds good, right?   

The concept of manager discretion — basing decisions on good judgment — empowers managers. By embracing manager discretion, companies are trusting managers to consistently make proper decisions about pay. Still sound good?

But what happens when those decisions are not consistent? Managers are human, they have biases. They have bad days and good days. In the morning, when making decisions for half of the team, manager Dan was in a great mood. He had just learned about an exciting new project.  Later that same day, Dan had a disagreement with a colleague and his mood turned sour. The compensation decisions for the remaining team members were made by sour Dan. Of course, the morning and afternoon decisions were different.

Judgments Vary — A Problem in Compensation Decisions

Research shows that decisions by people are far less consistent than we often think. And the amount of variation can be significant — even when based on the exact same set of data.  

What’s more, variation in compensation decisions can have serious consequences for an employer. The knock-on effect in our example might be that those employees who were unfortunate enough to have their discretionary bonus decision made when manager Dan was in a foul mood, will feel slighted. Maybe they will be less motivated. Some might start looking for another job. 

The result of inconsistent compensation decisions can be dissatisfied employees, unfair decisions and disparate impact.

Noise Can Be Identified and Removed

Any time there is judgment, there is deviation and inconsistency. That is reality. 

The inconsistency in decisions is the topic of the highly acclaimed new book, Noise: A Flaw in Human Judgment. Deviation in judgments is called “noise.”  It is an amazing book, written by Daniel Kahneman (Nobel Prize winner in Economics), Olivier Sibony (Professor at the HEC Paris Business School) and Cass Sunstein (Harvard Professor and co-author of Nudge). 

Most of the time, individuals and organizations are not aware of the noise. Managers making compensation recommendations neglect to consider the noise. With a few simple remedies, people can reduce both noise and bias, and make far better decisions.  

The notion that judgments vary when reviewing specific information is not new. Many research studies over the years have shown this to be true. 

But what is new — and well documented in the book Noise — is a way to identify where noise comes from and how to remove it. The result: better decisions.

The best way to avoid the dangers that come from bias in compensation decisions is to develop an effective decision-making architecture. This cuts down on the noise. A decision support tool can be easily implemented. It helps managers be intentional, fair and consistent when applying their discretion to compensation awards.  

For example, to reduce noise, give managers a short checklist to review when making each compensation recommendation. The checklist might be a short set of questions to consider when reviewing compensation for all team members.   

Managers answer the same questions for each colleague. It might include a scale to measure results. By applying discipline and structure to the compensation decision process, managers are continuously reminded about what factors should be used in reaching each decision. Some might say this takes away from manager discretion. Actually, it helps managers apply their discretion in the best way.  

Case Study

To counteract bias in compensation recommendations and decisions, an employer added a manager support tool to the compensation process in collaboration with HRSoft. Let’s call it “Comp-Assist.” 

The concept is to break the compensation decision down to a few core components that should influence the recommendation being made. Comp-Assist is a way to minimize bias in compensation decisions and is especially relevant when managers have a high level of discretion in making compensation decisions for their team.

During the compensation cycle when managers are making individual recommendations about compensation awards:

  • Comp-Assist is used to ask the manager to answer three questions regarding each employee on their team.
  • Comp-Assist calculates a score based on the responses.
  • The score is applied to the recommended award or guideline to determine an unbiased value for employees.
  • Comp-Assist is designed to use client-specified questions and weightings to determine the score. These can vary for different departments in the company.

 

A manager using this approach will be guided to apply their discretion in a consistent way. The result: better decisions and employees being rewarded properly. 

By having managers consider the factors that should drive compensation decisions, noise can be reduced. The key is consistency and clear communication about how to use this type of process. 

About the Author

Ezra Schneier is a corporate development officer at HRSoft Inc.