When you pay employees less than their market value, you are underpaying them. Market value is partially based on their experience, the type of job they are performing, and the cost of living in the area they live in.

Most employers understand the importance of paying their employees what they are worth. However, it is important to know what can happen if you don't. Here are a few consequences of underpaying your employees.

Employees do not stay at a job if they feel underpaid. In fact, 59% of employees say that being underpaid is the main factor why they quit a job.

One of the first things prospective employees look at in a job posting is the rate of pay. According to a study done by Glassdoor, salary is the number-one motivator for 67% of applicants. There is more that goes into a job other than salary, such as benefits, culture, growth opportunities, and company stability. Those are all important things. However, salary is clearly one of the first things applicants look for. If compensation does not match market value, candidates are less likely to apply for the role. Underpaying your employees can make it difficult to recruit new talent.

Morale decreases partly as a domino effect from the first two consequences. When it is harder to retain and bring in new talent, it can put a strain on the current workforce. As it takes longer to backfill positions of employees who leave, more work is put on other employees, often without being compensated fairly for the new responsibilities. This can lead to more employee burnout, which results in decreased productivity and even more turnover. Additionally, at a micro level, one disgruntled employee who feels they are underpaid can negatively affect a team’s morale. Employees with low morale become disengaged, which can lead to loss in productivity, absenteeism, and other detrimental factors.

Most companies don’t want to underpay their employees. Typically, companies do what they can to ensure their employees are being paid what they perceive as market value. However, often employees become underpaid over time. Here are common causes of that cycle.

Many companies implement an annual review/salary increase policy where raises are only given at the end of the year after performance and budget reviews. Often this results in 3-5% raises, which can be perceived as cost of living increases. While this process makes sense from a business perspective, it fails to factor in market value. The value of a job can increase dramatically from year to year. For example, say a lot of technology companies have sprung up in your company’s geographic area or market over the last year, and there is more demand for software engineers. If you want to keep them, your higher-performing software engineers likely deserve more than a 3-5% pay increase.

Many employees don’t know they are underpaid because they don’t know what their co-workers or employees of other organizations are paid. They also aren’t sure what they’re worth because they are unable to compare it to someone else’s wages. This is caused by companies not being transparent about pay when they post a new job or companies discouraging employees from discussing pay with each other. Many companies don’t post a salary range for a position or discourage employees from discussing their rate of pay because they are worried about backlash from current employees. New laws are helping with this, as states such as Colorado or New York require salary ranges when posting jobs. If a company refuses to be transparent about their wages, they are likely underpaying some of their employees, and potential candidates know this.

Many employees use their job title as a point of reference for their market value. However, while a job title is supposed to provide guidance on what a job entails, they do not cover all the details. Employees may be given additional job responsibilities that are not shown in their job title, which makes it harder for them or their employer to know what they should be getting paid without a proper job analysis.

As an employer, it is important to stay proactive with compensation. If you don’t, it is easy to fall behind and underpay your employees. We have discussed the consequences of underpaying your employees and how it might occur. This section provides methods you can use to help avoid underpaying employees.

As mentioned previously, wages for a specific job can change dramatically and quickly. A company needs to stay aware of what an employee should be paid based on their job title and responsibilities. Companies should perform compensation analysis on a periodic basis (quarterly, twice a year, yearly) to see how their employee’s wages compare to other companies'. Wages should be compared to similar job titles and duties in similar markets. After doing this analysis, companies should increase employees' wages to match what they should be getting paid. This will require leadership approval. One way to approach that conversation is to provide data from the compensation analysis to leadership and let them know the ramifications if they continue to underpay employees.

As was mentioned earlier, one of the more common reasons employees are underpaid is because they are given additional job responsibilities while their job title and pay remains the same. Just as a compensation analysis should occur on a periodic basis, a company should review employees' responsibilities as they change to determine whether the additional responsibilities merit a raise for the employee.

Many employees don’t like to discuss their salary with their manager for fear of rejection or looking ungrateful. Many employees are unsure how to negotiate their salary, even if they are unhappy with it, so they tough it out. This leads to employees being disgruntled without managers realizing it. One way employers can help avoid this is for managers to discuss compensation with employees often. Be open and transparent about wages. More conversations between employees and their managers about being paid fairly help managers remain aware of whether employees feel fairly compensated.

If an employer recognizes that an employee is being underpaid, it is important to handle the situation as quickly as possible. Here is step-by-step guidance on what to do when it has been discovered that an employee is underpaid.

You need to determine what the employee should be paid. Wage analysis studies compare the employee's job and responsibilities to your other employees and to employees in the market who are performing similar duties.

After determining what an employee should be paid, propose a raise for this employee to your manager or to leadership (depending on if it is multiple employees or what role it is for). Make a case on why this raise is justified and when it should occur. Your manager or leadership may initially reject the raise. If they do, let them know the possible consequences of continued underpayment. If the company decides to continue underpaying, ask when you can have a follow-up conversation on this issue.

Let the employee know what you have done to determine what they should be paid. This follow-up conversation may require letting the employee know that you are unable to give them a raise at this point due to leadership decisions or budget limitations. If so, do the best you can to let the employee know you understand their frustrations. Give them a timeline of when they might be eligible for this raise, or recommend what they can do to show leadership/management that they are worth the raise. The key to these conversations is to listen to the employee and make sure they know you are there for them.