Why do you think that pay equity is important consideration in preparing compensation packages?

What Is Equity Compensation?

Equity compensation is non-cash pay that is offered to employees. Equity compensation may include options, restricted stock, and performance shares; all of these investment vehicles represent ownership in the firm for a company's employees.

Equity compensation allows the employees of the firm to share in the profits via appreciation and can encourage retention, particularly if there are vesting requirements. At times, equity compensation may accompany a below-market salary.

Key Takeaways

• Equity compensation is non-cash pay that is offered to employees.
• Equity compensation may include options, restricted stock, and performance shares; all of these investment vehicles represent ownership in the firm for a company's employees.
• At times, equity compensation may accompany a below-market salary.
• Equity compensation is a benefit provided by many public companies and some private companies, especially startup companies.

Understanding Equity Compensation

Equity compensation is a benefit provided by many public companies and some private companies, especially startup companies. Recently launched firms may lack the cash or want to invest cash flow into growth initiatives, making equity compensation an option to attract high-quality employees. Traditionally, technology companies in both the start-up phase and more mature companies have used equity compensation to reward employees.

With equity compensation, there is never a guarantee that your equity stake will actually pay off. As opposed to equity (or in combination with equity compensation), being paid a salary can be beneficial if you know exactly what you're getting. There are many variables that can impact your equity compensation.

Types of Equity Compensation

Stock Options

Companies that offer equity compensation can give employees stock options that offer the right to purchase shares of the companies' stocks at a predetermined price, also referred to as exercise price. This right may vest with time, allowing employees to gain control of this option after working for the company for a certain period of time. When the option vests, they gain the right to sell or transfer the option. This method encourages employees to stick with the company for the long term. However, the option typically has an expiration.

Employees who have this option are not considered stockholders and do not share the same rights as shareholders. There are different tax consequences to options that are vested versus those that are not, so employees must look into what tax rules apply to their specific situations.

Non-Qualified Stock Options (NSOs) and Incentive Stock Options (ISOs)

Additional types of equity compensation include non-qualified stock options (NSO) and incentive stock options (ISOs). ISOs are only available to employees (and not non-employee directors or consultants). These options provide special tax advantages. For example, with non-qualified stock options, employers do not have to report when they receive this option or when it becomes exercisable.

Restricted Stock

Restricted stock requires the completion of a vesting period. Vesting may be done all at once after a certain period of time. Alternatively, vesting may be done equally over a set period of years, or any other combination that the management of a company finds suitable. Restricted stock units (RSUs) are similar, but they represent the company's promise to pay shares based on a vesting schedule. This offers some advantages to the company, but employees do not gain any rights of stock ownership, such as voting, until the shares are earned and issued.

Performance Shares

Performance shares are awarded only if certain specified measures are met. These could include metrics, such as an earnings per share (EPS) target, return on equity (ROE), or the total return of the company's stock in relation to an index. Typically, performance periods are over a multi-year time horizon.

Increased social awareness and workplace transparency have made pay equity more than just a standard compliance issue for many businesses today. In addition to avoiding potential litigation, forward-thinking employers who implement fair pay policies may be able to improve their organization’s reputation, keep employees engaged and attract new talent.

What is pay equity?

Pay equity is the concept of compensating employees who have similar job functions with comparably equal pay, regardless of their gender, race, ethnicity or other status. Yet, this practice is often more complex than simply eliminating biases. Employers must weigh other factors, like the employee’s education and work experience, the responsibilities of the position, and the organization’s long-term financial stability.

Why is pay equity important?

While pay equity has merits in social responsibility, it’s also important to a business’s bottom line. Employers who implement fair pay policies may be able to:

• Prevent discrimination lawsuits
• Comply with equal pay regulations
• Improve productivity and morale
• Reduce workplace turnover
• Attract talented new employees

What laws govern pay equity in the United States?

Federal laws governing pay equity were first enacted in the early 1960s. The two most notable are: 

1. Equal Pay Act of 1963
   This law states that men and women employed at the same business should receive equal pay for equal work.
2. Title VII of the Civil Rights Act of 1964
   Title VII offers broader protections than the Equal Pay Act and prohibits pay discrimination based on not just gender, but also race, color, religion and nation of origin.

Pay equity examples

The Equal Pay Act emphasizes the importance of job function over job title. Take administrative assistants and secretaries for example. These roles are typically similar in nature, so if one was performed by a male and the other by a female, and both had the same level of education and experience, then the two should receive relatively equal wages under the law.

How are state and local governments addressing pay equity issues?

Almost all states have equal pay laws, some more elaborate than others. New York, for instance, has expanded the definition of equal work to include “substantially similar” work.

Pay scale disclosure laws

Some regions of the country believe that transparency is an important part of improving pay equity. Colorado and New York City (effective November 2022) are the most stringent in this regard, requiring businesses to include the minimum and maximum pay range in their job advertisements. Employers, more than ever, will need accurate compensation data to comply with these regulations, which could become a trend in other states.

Salary history bans

Another way that state and local governments are addressing pay discrimination is by prohibiting salary history inquiries. Like other pay equity regulations, these bans vary greatly. For instance, laws may:

• Prevent employers from setting compensation based on salary history
• Restrict questions about salary history entirely
• Permit inquiries post-offer, but not pre-offer
• Treat internal and external job applicants differently

To help ensure compliance with state and local pay equity laws, employers should check state legislature websites or seek legal counsel.

How can employers implement or improve their pay equity policies?

Complying with pay equity legislation often starts with taking a hard look at existing company policies and making proactive changes, such as:

1. Documenting pay equity strategies and updating job descriptions and pay structures to align with new policies.
2. Communicating with employees about the company’s pay equity goals and how it plans to achieve them.
3. Adjusting recruitment and talent management tactics if one particular race or gender constitutes the majority of certain roles or departments.
4. Conducting a pay equity analysis to identify any potential wage gaps that may be the result of discrimination and correcting them.
5. Partnering with a professional employer organization (PEO) for additional support managing compensation data and pay audits.

What is a pay equity analysis?

A pay equity analysis is a statistical way of identifying pay gaps within an organization. It does so by cross referencing pay scales against any number of criteria – gender, ethnicity, education, seniority, etc. Discrepancies that cannot be explained by legitimate, non-discriminatory reasons require further investigation and corrective action on behalf of the employer.

How do employers perform a pay equity analysis or audit?

A pay equity audit is a complex process that requires data analysis and the expertise of financial advisors and attorneys. Businesses that have these resources available to them generally follow these steps:

1. Lay the groundwork
   Agree with key stakeholders on the reason for the audit, its methodology, scope, budget and timeline.
2. Have historical perspective
   Knowing how the current pay scales were created can help address any potential issues that are found as a result of the audit.
3. Collect workforce data
   The scope of the audit largely dictates the type of information gathered, but most look at job function, gender, race, experience, length of service and job performance, among other factors.
4. Compare employees with similar job functions
   During the comparison, it’s important for employers to understand the pay equity laws in their state, since some have broader definitions of “equal work” than the federal government. “Comparable” and “substantially similar” standards may apply.
5. Review and interpret the findings
   If differences in pay are discovered, do not automatically assume that they are illegitimate. Those based on merit, seniority and quantity or quality of production are generally acceptable. Look for wage gaps that could be directly related to protected characteristics.
6. Correct wage gaps that are not justified
   Consult with leaders in HR and finance on the most fiscally responsible way to increase the wages of any employees who may have been the subject of discrimination. Cutting pay to fix wage gaps is generally prohibited.

What are some best practices for fair pay?

In addition to performing a pay equity audit, employers may be able to reduce pay inequality by following best practices, such as these:

• Review compensation trends
  Track how pay matches up to different groups of employees and use external benchmarks to create hiring and compensation practices that are consistent with industry standards.
• Be transparent about pay
  When employees know how pay decisions are made, it helps create an environment of trust and compels managers to justify that raises are based on performance.
• Prohibit salary negotiations
  Rely on clearly communicated objectives as the rationale for bonuses and raises instead of reacting to employees who ask for more money or threaten to leave.
• Prioritize budgets
  Because it’s a financial investment, closing wage gaps requires careful budget planning and the ability to manage conflicting priorities.

Frequently asked questions about pay equity

What are the factors that relate to pay equity?

While it’s true that pay equity is about achieving equal pay for equal work, there’s more to it than just that. Employers must also weigh their employees’ education, experience or skill level, years with the organization, and performance to create pay scales that are based on merit.

What is the Equal Pay Act?

An amendment to the Fair Labor Standards Act, the Equal Pay Act prohibits wage discrimination based on gender. It covers all forms of compensation and applies to men and women who work for the same employer and have substantially equal jobs. If a wage inequality is discovered between individuals who meet these criteria, the employer must correct it by raising wages, not cutting them.

How is pay equity calculated?

The gender pay gap is generally estimated by dividing the median earnings of women by the median earnings of men and expressing the answer as a ratio or percentage. Results vary depending on if the wages were adjusted for variables, such as occupation, hours worked, education and work experience.

How do you ensure internal pay equity?

Achieving pay equity is a multi-faceted process that takes time and depending on internal resources, may require external help to be fully realized. Despite these challenges, businesses typically can ensure their compensation policies are fair by:

• Researching what other businesses in the same industry are paying employees
• Refraining from salary negotiations, which can put women and underrepresented groups at a disadvantage
• Basing raises and bonuses strictly on performance and merit
• Analyzing results from a pay equity audit to spot signs of wage discrimination

This guide is intended to be used as a starting point in analyzing pay equity and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.

What is the importance of pay equity?

Is equity an important consideration in compensation?

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Why is it essential to ensure that there is fairness and equity in the pay structure of an organization?