Pay compression: causes, legal limits, and how to fix it

Executive overview

New hires often earn more than experienced employees doing the same job. This erodes retention and creates a hidden loyalty tax on long-tenured staff.

The fix is not secrecy — it backfires legally and culturally. Transparent compensation practices, including published salary bands and levels documents, directly counter pay compression while improving both recruiting and retention.

The pay compression problem

• Pay compression occurs when little or no pay difference exists despite seniority, experience, or skill differences
• New hires negotiating above-market salaries push wages past those of current employees
• A 2022 Labor IQ study of 20,000 job titles found new hire salaries average 7% higher than incumbents in the same role
• The gap rises to 20% in high-demand fields like finance and tech
• Top talent responds faster to market pressures than most organizations — leading to avoidable turnover

What employers cannot do

• Banning pay discussions between employees is illegal under the National Labor Relations Act (NLRA)
• Employees may discuss wages on breaks, off-hours, or during work if other non-work conversation is permitted
• A written policy banning pay discussions provides no legal protection
• An NLRB case involving a diaper supply company in St. Louis required the company to reverse the firing, pay full back pay, and revise its policy
• Relying on employee discomfort to suppress pay talk is not a strategy — it obscures problems rather than solving them

How transparency fixes pay compression

• Publishing salary ranges in job postings discourages inflated salary negotiation by new hires
• Current employees can see what new hires earn, reducing feelings of being left behind
• Only ~12% of job postings include salary information — a major gap given the retention stakes
• A 2021 report found 58% of employees would consider leaving for an employer with better pay transparency
• When posted salaries need to increase to stay competitive, current employees should receive raises too

Levels documents and target compensation

• Target compensation defines expected earnings for a reasonably good performer in a given role
• Levels documents show employees how compensation is calculated and what advancement requires
• Compensation within each team is based on years of experience plus a combined score of job scope and skill
• Making levels documents available to all staff removes ambiguity and signals respect
• This approach draws on Joel Spolsky's model (Stack Overflow, Fog Creek Software), outlined in his Inc. article "Why I Never Let Employees Negotiate a Raise"

Key tradeoffs and stakes

• Pay compression is a compounding problem — delay makes it more costly and harder to unwind
• Addressing it increases payroll short-term; ignoring it increases recruiting costs long-term
• Candidates who reject a fixed salary may be self-selecting out of a culture built on fairness
• A reputation for underpaying current employees is more damaging to recruitment than posting a firm salary range