Pay Transparency is the New Black

Joe Employee Earns What?

Under the Dodd–Frank Wall Street Reform Act of 2010, there is a yet-to-be-finalized rule that will require all publicly-traded companies to disclose the ratio of the CEO’s salary compared to the median salary of all employees at the company.  The proposed rule, commonly referred to as the “CEO pay ratio,” is expected to be finalized by the end of 2015.

The CEO pay ratio has been talked about as a burdensome and expensive administrative headache, forcing companies to gather payroll and benefits information to both determine their median-paid employee and to calculate the median total pay of that employee. The calculation must include part-time and seasonal workers, as well as employees in all corners of the world. The mandate all but ensures an inaccurate reflection of total pay according to position, location and myriad other factors, leading many to brand it as a useless number that bears little to no value for investors.

The simple fact is CEO pay is already a required disclosure. Anyone can open their company’s proxy statement today and do some simple arithmetic to calculate the ratio between his or her pay and the big boss, though most do not. For example, if an employee’s total pay (including benefits) is $50,000 and the CEO’s total pay is $10,000,000, it’s not difficult to calculate that the CEO’s pay is 200 times that of the employee. Within that single data point lies the easy headlines, stoking the pay inequality topic and many hot debates.

The issue is already brewing if we go beyond the surface of the CEO pay ratio and the challenges it will bring. There are already many who grumble about top executive pay that seems to be in the stratosphere and lament their own number in comparison, but most can rationalize the difference between what they earn and what the most senior people at their company earn, even if they don’t fully understand why the figures are so different.  What we haven’t seen before is public access to the median pay of all employees. This number and its questionable value are new factors that change visibility and the pay communication game completely. 

A Basis for Unhealthy Comparisons

While intended to highlight CEO pay, the ratio will also give people the ability see the difference between what they earn and what the median employee earns at his or her company. This may seem like a realistic basis for comparison. People will begin to compare themselves to Joe Employee: Who is Joe Employee? What does Joe Employee do? Where does Joe Employee work? How is Joe Employee’s job different than mine?  Why does Joe Employee make more (or less) money than me? Is that fair? 

The danger is that without a baseline education across the workforce about how salaries, merit increases and incentive payouts are determined—and how they rightfully differ among job roles, responsibilities and geographies—these inevitable comparisons are likely to be unrealistic. There is real risk of heightened employee disengagement and erosion of trust in the employer. Further complicating the issue is the need to go beyond the baseline. People also need assurances that their pay is set and delivered according to fair governance policies and well-thought out processes that are aligned with business strategy.  It’s the only way employees will have a better and more accurate understanding of where they fit into the structure of their company and how they can affect the right drivers of performance.

The Best Defense Is a Good Offense

Even without the CEO pay ratio looming, we know there is room for improvement in how companies are communicating about pay with their workforces. According to a recent Pearl Meyer & Partners’ OnPoint survey “Creating Engagement Through Executive Compensation Communication,” less than 70% of employers felt employees had a good understanding of their pay programs and only about half of those 70% think their employees would rate the value of their pay programs as high. And while most companies—about 90%—focus key messages on pay for performance, information about how pay is set and the decision-making process is lower on the priority list.

Given the looming changes in disclosure rules, the latest industry research and the full court press in the media about pay inequality, HR leaders are in the best position to refocus the conversation by communicating information in three key areas:

1. Base salaries — Providing a clear explanation of how base salaries are derived for your industry (e.g., benchmarking, market pay position) is an important starting point. It gives people a baseline for apples to apples comparisons.  It also helps to share internal pay ranges and how they work (e.g., job families, geographic differences, career tracks). Giving people an understanding of where they fit within the company (for example, Human Resources) and how their role is valued (for example, a generalist versus a compensation analyst) helps fill in some of the mystery.
2. Incentive plans — Regardless of the form of the award (cash or equity), communication should include clear summaries for the performance measures and targets of the plans and ways that employees, based on their respective roles within the organization, can impact results (often called “line of sight” to business objectives.) It’s also important to be clear about how bonus pools are funded. 
3. Governance — People need to know who is making decisions about their pay and when, as well as all of the factors that contribute to the decision. This applies to merit increases and incentive payouts, especially if discretion is a part of the equation.

Sharing this type of information, with the right level of detail and delivered by the right sources, makes it less likely people will make uneducated comparisons about how they are paid relative to their internal peers.  Of course, this requires developing and implementing a comprehensive pay communication strategy and education plan that outlines your audiences, key messages, timing and methods of communication delivery.

So maximize your runway. Use this valuable time between now and the end of the year to map out your plan, develop your materials and train the right people. You can get ahead of your next round of pay discussions, your company’s proxy statement disclosure and the CEO pay ratio.

We’ve all been there at one time or another and there’s nothing worse than having an annual pay discussion with your manager and being disappointed. An underwhelming single-digit merit increase and lower-than-target bonus leave you feeling like you could have done more, yet wondering what exactly. As HR professionals, one of the best approaches is ensuring no one in your company has this question. A solid communication plan is an excellent place to start and the timing now is just right.