Pay Equity Deep Dive Series: Part 1

We’re seeing more organizations take action on pay equity. According to a 2022 WorldatWork survey, 70% of participating organizations reported taking action on pay equity, representing a ten-percentage point increase from 2019. Moreover, of those taking action on pay equity, 80% have an ongoing process for conducting a pay equity analysis. 

With this in mind, over the next few months, we’ll be taking a deep dive into the process of conducting a pay equity review. 

The Concept of Pay Equity

Before we begin, it’s important to understand what is meant by pay equity. 

Most people are familiar with the raw pay gap, which tells us how average or median pay differs by demographic group. For example, the UK gender pay gap report requires companies with 250+ employees to report, among other things, the median pay of women as compared to the median pay of men. 

Conceptually, the raw pay gap can be broken down into two components: 

Explained pay gap: One component reflects the extent to which pay differs by demographic group due to relevant differences among those groups in compensable factors such as occupation, career level, education, and experience. We call this the “explained” pay gap. Since this explained pay gap reflects differences across demographic groups in career level, managerial responsibility, time with the organization, performance reviews, etc., it can embody or include inequities in hiring, promotion, performance assessment, advancement, and retention. Addressing such inequities in opportunity are important but are not the focus of pay equity. 

“Unexplained” pay gap: Instead, pay equity focuses on the second component of the raw pay gap, which is not explained by those relevant compensable differences. This remaining “unexplained” pay gap is attributable to differences in gender, race/ethnicity, or another protected demographic characteristic. You may also see this pay disparity referred to as the “adjusted” or “controlled” pay gap. While it’s important for companies to address both explained and unexplained pay gaps, the objective of a pay equity review is to measure an organization’s unexplained pay gap and close it where appropriate.

Pay Equity Review Process

When conducting a pay equity review, we break down the process into five phases:

• Setting the Foundation,
• Model Development,
• Preliminary Results,
• Fair Pay Strategy,
• and Ongoing Monitoring

Each has its own set of activities. The graphic below outlines the phases and key activities.

If you’ve conducted a pay equity review, you’re probably familiar with many of these activities—e.g., establishing attorney/client privilege protocols, defining the scope of the review, data acquisition and processing, conducting multiple regression analysis, developing a remediation strategy, identifying employees potentially requiring an adjustment, stakeholder communication, and conducting on-going refreshes. 

Others may be less familiar—e.g., compensation philosophy review; Pay Analysis Group (PAG) formation and testing; Wage Influencing Factor (WIF) identification, selection, consolidation, and assessment; Tainted Variable Analysis (TVA); reliability and robustness testing; root cause review; and Salary Range Finder (SRF). 

It’s these latter activities that we’ll be focusing on in this Pay Equity Deep-Dive series. Part 1 of the series focuses on Compensation Philosophy Review and Pay Analysis Group formation and testing.

Compensation Philosophy Review

A compensation philosophy review involves developing an understanding of your organization’s compensation strategy, primary pay programs, and market position. Specifically, here are some of the key questions a compensation philosophy review seeks to understand:

1. What are the primary objectives of your compensation strategy?
2. What employee groups are eligible for variable compensation? What percentage of pay is base vs. variable across different employee groups? How formulaic is variable pay?
3. What degree of discretion do managers have in setting pay (both base and variable)?
4. Do you have sales employees, and how are they compensated?
5. Do you have geographic differentials?
6. What is your target market position? Does this differ by employee group?

Responses to these questions play an important role in guiding key decisions about your pay equity analysis, such as what employees should be included and excluded from your analysis, what compensation types should be the focus of the analysis, what data will be needed to analyze these compensation types, and how should your workforce be segmented for analysis purposes?

Here are three sample scenarios:

Scenario	Implication
Company’s bonus awards are formulaic and based on an employee’s base salary and career level (e.g., all employees at the manager level receive a bonus that is 15% of their base salary; all employees at the director level receive a bonus that is 20% of their base salary). Managers do not have the discretion to differentiate bonus awards based on performance.	In this scenario, managers have no discretion in determining bonus awards, and thus it’s not likely advisable to examine the equity of bonus awards directly. Instead, to ensure bonuses are equitable, the focus should be on ensuring that base salary and level placement are equitable, since these completely determine an individual’s bonus.
Company has both sales and non-sales employees. The primary form of compensation for their sales workforce is total target compensation (TTC), which is base salary plus the commission paid for meeting their sales target. The primary form of compensation for their non-sales workforce is base salary.	In this scenario, it’s advisable for the company to run separate pay equity analyses for its sales workforce and its non-sales workforce. For sales employees, the analysis would focus on an examination of TTC. For non-sales employees, the analysis would focus on an examination of base salary.
Company has both union and non-union employees. Managers have discretion over the pay of their non-union workforce, while pay for their union workforce is determined by a collective bargaining agreement (CBA). The CBA was recently renegotiated and will be in effect for the next three years.	In this scenario, it may be advisable to exclude the union workforce from the pay equity analysis and focus the analysis on the non-union workforce. Since the CBA was recently negotiated and in effect for several years, the results of a pay equity analysis may not be actionable now. As the contract nears expiration, it may be advisable to conduct a pay equity analysis of the union workforce and use the results during the renegotiation process to ensure pay is fair for the union workforce.

 

Pay Analysis Group (PAG) Formation & Testing

A critical foundational step in conducting a pay equity analysis is deciding how to segment your workforce into Pay Analysis Groups (PAGs). The purpose of the PAG formation process is to group employees into meaningful pools for comparison purposes. Once your PAGs have been formed, a pay model is developed for each one. 

The formation of PAGs is driven by multiple considerations, including differences in pay philosophy/pay practices (e.g., commission-eligible employees vs. non-commission eligible employees), nature of the work being done (e.g., functional area, line of business), geographic boundaries (e.g., country, region), and the degree of manager latitude or discretion in setting pay (e.g., little discretion vs. considerable discretion). 

The formation process needs to balance “differentiation,” which allows you to capture unique pay practices associated with different parts of your workforce, and “pooling,” which improves the statistical power of your analyses. 

To help you think through the PAG formation process for your organization, the figure below summarizes the trade-offs associated with two different PAG creation approaches: 

1. Many Differentiated PAGs: Approach involves creating a larger number of PAGs, typically based on a more granular concept of the nature of work, such as job or job group.
2. Fewer Pooled PAGs: Approach involves creating a smaller number of PAGs, typically based on a more aggregated concept of the nature of work, such as function or line of business.

Selecting the appropriate segmentation for your workforce requires you to balance the trade-offs above. To assist organizations with creating their PAGs, Trusaic uses the results of the compensation philosophy review to create multiple segmentations for consideration and then conducts a series of statistical tests to identify the preferred segmentation.

For example, for one organization, we evaluated the following potential segmentations:

1. Job Family
2. EEO-1 Job Category
3. Organization Level
4. Manager/Non-Manager
5. Job Level

For the Job Family segmentation testing, we examined each individual job family (e.g., marketing, sales, technology, human resources, finance, legal) and investigated to what extent each one was distinct from other job families in terms of how pay is determined and whether a job family could be combined with other job families. 

This same process was followed for all the segmentation options above. From there, we compared and ranked the relative performance of the five segmentation options in terms of their ability to explain the observed variation in pay within the organization. The client used these results to select a final segmentation that served as the foundation for the model development phase.    

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Stay tuned for Part 2 of our Pay Equity Deep-Dive series where we’ll talk about Wage Influencing Factor (WIF) identification, selection, consolidation, and assessment, plus reliability and robustness testing.