Is Salary a Leading or Lagging Indicator?

Getting Deliberate with Compensation Structures

Given an unpredictable world, the push to be “data-driven” is understandable (even as the term becomes increasingly overused and misunderstood). We like to think our decisions arise from facts that will lead us in the right direction. It’s tempting to think we can avoid unpleasant surprises if we just have enough information and effectively pivot when we need to. 

Data is useful, but, like any tool, it is only as good as our ability to apply it correctly. If we misinterpret data (knowingly or not), we feel fully prepared to make bad decisions confidently. 

Urban legend tells the story of a doctor who believed he had found a diagnostic tool for typhoid fever when he started feeling his patients’ tongues and accurately predicted typhoid before symptoms began. In reality, the correct diagnosis arose from his ability to transfer typhoid from one patient’s mouth to the next via his hands. 

To practice better use of data, let’s look at leading versus lagging indicators and apply them to a relatable concern for all - compensation.

Defining Leading And Lagging Indicators

We can break decision metrics into two camps: lagging and leading indicators. A lagging indicator illuminates how past actions affect the present; leading indicators aim to predict what will happen next. 

Lagging indicators are much more common, and they are easy to mistake for leading indicators. Customer churn rates, employee satisfaction, and performance reviews are all lagging indicators. When we evaluate employee performance in the last six months, we use lagging data. It’s tempting to look at trends and believe we can predict how an employee will perform in the future, but these predictions rely on too little data to be accurate. An uptick in employee satisfaction may indicate new culture initiatives are working, but not that satisfaction will continually improve. An increase in churn may say something about the marketplace or a need to overhaul sales strategies, but they do not necessarily indicate what will turn the ship around.

Leading indicators are more difficult to find because accurate prediction is difficult. In medicine, swollen lymph nodes may indicate an impending infection. In economics, the consumer confidence index or jobless claims are used as leading indicators of where the market will go. Meteorology constantly works to find leading indicators for the weather, but accurate predictions are rare. 

We must carefully avoid using a lagging indicator as a leading indicator or using a leading indicator as truth.

So what does salary indicate?

Disclaimer: salary is NOT the only motivating factor for people. It is used in our thought experiment here because it is a common feature of any job, but personal motivation comes from a unique mixture of purpose, value alignment, appreciation, compensation, circumstance.

Applying the concept of leading and lagging indicators, how does salary relate to the value of a person’s work? Is it an indication of how they have performed up to this point? Is it an indication of how well they will perform? Is it an average of how well they are expected to perform over the next performance period?

We often think of raises as “earned” when a certain standard of work is met (so it is a lagging indicator). This connotation implies employees are underpaid while they prove their worth, which leaves the employee taking a risk if a raise or promotion is not available later, which could disincentivize them. On the flip side, if we believe salary is a measure of how much an employee will do (treating it more like a leading indicator), the employer is taking a risk that the employee will not meet the standard, and the company will overpay. 

In practice, since employers make the final decisions on compensation, the risk is usually pushed to the employees. On the surface, this makes some sense – employers are in charge of running the business as a whole, which means working to distribute salary as best as possible in recognition of good work and in continued efforts to retain and encourage talent (while keeping an eye on cash flow for an uncertain future). This view does not capture the nuances of compensation dynamics for the employee, however.

Given the complexities of the reality of compensation, we need to be careful about the messaging around salary. For example, incentivizing good work by tying raises to a performance framework sounds good on paper until the budget cannot deliver on those promises. Most employees understand that market and business conditions affect what is possible. They will understand if compensation changes cannot happen immediately (as long as the reasoning is genuine). 

As leaders, setting expectations is crucial, and even more so around people’s livelihoods. This means working with employees to clarify that compensation is not solely based on individual performance, plus continually demonstrating good faith. In this case, good faith may look like rewarding incredible efforts with bonuses outside of the normal compensation cycle, or acknowledging good work and putting it in writing that compensation changes will be made as soon as the budget is available. If we do not create structures to reward people in good faith, we end up nurturing resentment.

Imagine being an employee who has performed exceptionally during the year. Normally, this would be rewarded with a raise per the employee handbook, but market conditions (like, say, a global pandemic) have shrunk the budget and the business. Simply saying a raise is not possible right now and saying nothing about when it will be possible implies the employee is now on hold, hoping that they can justify their performance in a year so they can maybe get that bonus at that time. Establishing how the employee can be rewarded (through other perks like more PTO or a written agreement to boost compensation when specific conditions make that possible), on the other hand, heads off this demotivating cycle.

Because there are so many contributing factors, we cannot use salary as a purely leading or lagging indicator for the value of someone’s work. Instead, we should consider what we want it to mean and its perception among our people, then create deliberate expectations to manifest that reality.