How to Create Pay Grades

Introduction
While there are no regulations or set standards regarding the establishment of pay grades, there are some basic, customary steps involved in doing so. Key components in establishing and maintaining pay grades include:

* Getting a commitment and participation from management and/or the executive team in establishing company minimum and maximum pay for the organization. * Using the company’s compensation philosophy to create pay grades that support that philosophy (will you lead the market, lag the market or pay at market?). * Determining how often you will adjust grades due to inflation or market changes going forward.

The purpose of this guide is to provide a basic set of steps for creating a pay grade system for an organization. This guide is intended for general use and should be tailored to meet each organization’s specific needs. The guide assumes that salary survey information has been obtained for all benchmark positions and that job evaluation (if desired) has already been conducted.

Step 1: Establish overall pay range
Determine a company minimum and a company maximum pay. The minimum will be for the first and lowest grade and the maximum will be for the last and highest grade. Use a listing of all company positions or job groups and current salary survey data relative to those positions to set these parameters and incorporate the company’s compensation philosophy to lead, lag or pay at market. (Paying at market means your midpoint will match the average salary for that position; lagging the market will set a midpoint below the average salary for that position; leading the market will set a midpoint above the average salary for that position). A pay range will generally spread +/- 15-20% from the midpoint, but any range the employer feels is appropriate is acceptable, and ranges may be different for different grades. For example, if your lowest paid position is an administrative assistant and you wish to pay at market, and salary survey data for that position shows an average salary of $25,000, a 15% spread for that job would be $21,250 (min), $25,000 (midpoint) and $28,750 (max), making $21,250 your overall minimum salary. Do the same for the highest paid position to set the overall maximum salary the company is currently willing to pay.

Step 2: Establish number of grades
Select the number of grades to be used based on the size of the company, job diversity, job evaluation results, etc. Large companies may find it more practical to use more grades (the federal government has 15 grades); small companies might elect to use fewer grades. For example, a small company with a CEO, managers who report to the CEO and administrative assistants might have three pay grades. A similar, larger company, perhaps with administrative staff, exempt professionals, supervisors, managers, directors and chiefs, may have six pay grades. An international company may have more than one pay grade system to reflect geographical differences. There is no one right number of pay grades; choose the number that makes most sense for your organization and its structure. Typically, however, the number of pay grades will depend on the size of your organization and the difference between the highest paid and lowest paid jobs. See the federal government’s grades at www.opm.gov/OCA/03tables/html/dcb.asp. Step 3: Establish a range per grade
Set a minimum and maximum for each grade. The maximum of one grade may overlap the minimum of another and vice versa. A common spread is +/- 15-20%, but it can be set at whatever the employer feels is acceptable. Many companies will average the midpoints (from salary survey data) of jobs in that grade to help establish a range for that grade. For example, a customer service position, a receptionist position and a mail clerk position may all be included in the same grade, and the averages of their midpoints from salary survey resources may be the midpoint you wish to set for that grade. Alternatively, if you are a software development company with many programmers on staff, you may have a range just for programmers and, if paying at market, may wish to use the midpoint directly from the salary survey resources for programmers as your midpoint of that grade. A range that has room for many experience levels and room for advancement will make for a balanced range.

Step 4: Create pay grade chart
Using the sum of the minimum and the maximum, calculate the midpoint by simply dividing that sum by two ([Max + Min] / 2 = Midpoint). You now have the key elements of your pay grade range determined, and your pay grade chart should look something like this:

Grade | Min | Mid | Max | 1 | $20,000 | $30,000 | $40,000 | 2 | $34,000 | $43,000 | $52,000 | 3 | $50,000 | $75,000 | $100,000 | 4 | $80,000 | $100,000 | $120,000 | 5 | $110,000 | $140,000 | $170,000 |

Step 5: Review and amend
Determine how often the pay grade will be reviewed and how often adjustments will be made. Annual salary and salary structure increase projections can be used to adjust as needed. Pay grades are typically reviewed every one to three years.

Keep in mind there are a number of discrimination laws that affect compensation, including the Equal Pay Act, Title VII of the Civil Rights Act and The Age Discrimination in Employment Act. It is extremely important to review your compensation plan to ensure there is no adverse impact to protected groups.

A typical method of calculating whether adverse impact exists in compensation plans is to use a multiple regression analysis. However, the use of such a statistical analysis is complex and beyond the scope of this guide. You should consult with a compensation professional to determine which approach is best for your organization.