How Does a Pay Grade Work?

Arrow on wall chart going up with stairs
••• Pay Grades Become Higher as Employees Are Promoted. Visage/Stockbyte/Getty Images

A pay grade is a step within a compensation system that defines the amount of pay an employee will receive. The pay grade is generally defined by the level of the responsibilities performed within the job description of the position, the authority exercised by the position, and the length of time the employee has performed the job.

Occasionally, the horizontal axis is related to the performance of the employee as well as the length of the employee's service. The vertical steps in a pay grade chart refer to the level of the responsibilities defined by the job's requirements.

Pay grades provide a framework for compensation by defining the amount of pay available at each step in the employment process. Pay grades take the place of salary negotiation, particularly in public sector employment where fairness trumps contribution. Pay grades are also typical of union-represented positions.

An employee who is new to a job in a particular pay grade range starts at pay step one of the pay grade. If he or she continues to work in the same role, the pay grade allows upward movement in salary, usually one pay step per year of service within the pay grade assigned to that job.

Compensation systems involving pay grades are often used within public sector employment such as the Federal government, the military, and universities.

Pay steps within each pay grade differ between organizations and may involve as many as 10-15 or more pay steps before an employee reaches the top rate of pay for their pay grade. A pay raise, once an employee reaches the top of their pay grade is dependent on the cost of living allowances or increases.

The number of pay steps encourages employees to feel as if their career success and compensation are increasing during the time they perform the job - even if they are performing the same job. This is important as it is not always possible for every employee to obtain a promotion, a lateral move, or a move to a different internal job with more responsibilities to start moving up the pay steps of the next pay grade level.

If few increases existed via pay steps, employees feel stuck and unappreciated. This can affect employee morale and employee motivation adversely.

Overlaps in the amount of salary available at each pay step of the pay grade are common to pay grades. For example, a beginning worker's job at pay grade 1 might involve 10-15 pay steps from $18,000 to $24,000. Pay grade 2 assigns rates from $22,000 to $27,000 and so forth.

Pay grades are also useful in private sector employment. As a company grows larger, you want to ensure fairness and similar pay structures across different positions within a variety of work units and job functions.

Similar pay for similar job requirements and responsibilities ensures that each work unit can attract and retain excellent employees. Pay grades in the private sector can involve salary negotiation and the application of more managerial discretion than in its public sector counterparts.

See a Sample Pay Grade Chart

Also Known As: pay structures, pay systems