Equity of equity guide

Learn how to navigate the challenges of achieving pay equity in long-term incentives.

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Introduction

If you're like many companies, you're taking action on pay equity, but your focus has been on base pay. According to a 2022 WorldatWork survey, 85% of companies with an ongoing pay equity analysis process in place are examining base pay. On the other hand, only 30% are examining long-term incentives (LTI). While focusing solely on base pay may be appropriate for some organizations, if a relatively large percentage of your workforce is eligible for LTI, it may be time to expand your pay equity program to include equity compensation.

In this guide, we'll:

  • Define pay equity and why it matters.
  • Provide an overview of the key process steps for conducting a pay equity analysis.
  • Share some questions to consider as you think about whether it's time to focus on the equity of equity compensation.
  • Review the LTI landscape.
  • Take you through seven tips for analyzing the equity of equity compensation.
  • End with some caveats about pay equity and total compensation.

What Is Pay Equity and Why Does It Matter?

At its core, pay equity is the practice of ensuring employee compensation is based on legitimate, compensable factors, such as skill, effort, responsibility level, working conditions, and location.

On a more technical level, pay equity is the practice of measuring an organization's unexplained pay gap and closing it where appropriate. The unexplained pay gap refers to the part of the raw pay gap that cannot be explained by legitimate, compensable factors, and may be due to inequities based on gender, race/ethnicity, or another protected characteristic.

Pay equity matters for a variety of reasons. First and foremost, it's a legal imperative. There has been a host of new pay equity regulations and legislation over the past few years that has dramatically increased the amount of compliance and reporting activities for employers. Along with this is the ethical imperative to ensure that your employees are paid fairly. Pay equity is also an important part of attracting and retaining top talent, and more broadly, building a fair and equitable workplace.

Key Process Steps for Conducting a Pay Equity Analysis

Before discussing how to evaluate the equity of long-term incentives, it's worthwhile to review the key process steps for conducting a pay equity analysis. A pay equity analysis consists of five steps as illustrated in the figure below.

Data Preparation

Collect employee-level data-typically a snapshot of data as of a particular point in time. You'll want to collect compensation data as well as demographic data, such as gender and race/ethnicity. The data should also include legitimate, compensable factors that you would expect to drive pay outcomes. Common examples include job, job function, career level, company tenure, time in position, and performance rating.

Pay Analysis Groups (PAGs)

Grouping employees into meaningful segments-or what we call Pay Analysis Groups (PAGs)-is an important part of a pay equity analysis. Multiple considerations influence the development of PAGs.

  • First and foremost, differences in pay philosophy and pay practices should drive segmentation. Common examples include segmenting based on commission eligibility and overtime eligibility.
  • Segmentation should also reflect differences in the work being done. For some organizations, this might mean segmenting by functional area or job family. For others, it might mean segmenting by line of business. As an example, if you find that in your organization, people in the same job title are doing different work based on the line of business they support, you may want to segment by line of business and, perhaps, further segment by functional area or job family.
  • Segmentation should also reflect differences in geographic boundaries. This is particularly the case if salary structures are not comparable across geographies. The most common example is segmenting by country.
  • Lastly, you may want to account for the degree of manager discretion in setting pay. A common example of this is if you have both union and non-union employees in your organization. Assuming managers have little discretion in setting pay for their union employees yet have discretion over the pay of their non-union employees, you will likely want to segment by union status.

An important warning is that if you segment your workforce too finely, you may limit your statistical power. Most notably, limited statistical power will make it more difficult to detect pay inequities. Because of this, your PAG formation process needs to balance "differentiation," which enables you to capture unique pay practices associated with different parts of your workforce, and "pooling," which improves statistical power.

Multiple Regression Modeling

The third step in a pay equity analysis is to use multiple regression to run a pay model for each of your PAGs. These models will include the legitimate, compensable factors mentioned earlier that you would expect to influence pay outcomes, as well as the demographic characteristics you are interested in examining.

Assessment

During the assessment phase, you'll flag groups with statistically significant unexplained pay differences by gender, race/ethnicity, and other protected demographic characteristics. The statistical significance of a pay disparity is typically measured using a 5% significance level (i.e., p-value ≤ 0.05). This indicates that the result is unlikely to be due to chance and is statistically meaningful.

Remediation

During remediation, you'll identify and review employees in flagged PAGs who appear to be underpaid and make decisions about pay adjustments. Note that not all employees you identify for a pay adjustment will end up receiving one. Employees need to be reviewed one-by-one to determine if there is a legitimate reason that explains a specific employee's pay situation. If there is no legitimate explanation, then it's recommended to adjust the employee's pay.

Is It Time to Focus on the Equity of Equity Compensation?

As noted earlier, relatively few organizations that conduct pay equity analyses focus on equity compensation, although-as we'll share in more detail in the next section-executives are not the only employee groups commonly eligible for LTI. For example, according to Radford, more than 50% of those in senior-level Manager (M4-M6) and Professional (P5-P7) roles, as well as those in Technical/Scientific roles (T1-T7), are eligible for LTI. Moreover, as you might expect, LTI plays a larger role in some industries. In particular, employee eligibility exceeds 60%, on average, in Internet/Online Community (91%), Bio/Pharma Pre-Commercial (81%), Software Products/Services (66%), and Bio/Pharma Commercial (64%).

With this in mind, here are questions to consider as you think about whether it's time for you to conduct a pay equity analysis on your equity compensation. If you answer "yes" to these statements, then you may want to consider conducting a pay equity analysis of your LTI:

  1. Equity compensation plays an important role in your organization's compensation strategy.
  2. Equity compensation is not limited to your senior-most executives (e.g., your C-suite executives).
  3. Equity compensation decisions are not completely formulaic (that is, managers have some degree of discretion in making equity compensation decisions).

The LTI Landscape

As noted, long-term incentives play a pivotal role in executing your company's compensation strategy. As such, it is critical that your company is thoughtful in designing long-term incentive plans to ensure they are driving the right behaviors, aligned with your business and compensation strategy and internally equitable across the organization.

Considerations When Designing a Long-Term Incentive Program

In our experience, the most successful long-term incentive programs are highly aligned with the company's objectives and reflect the viewpoints of leaders across the organization, as each leader has a different lens from which they view effective incentives. A critical first step is identifying the guiding principles that will inform the design of the "ideal" long-term incentive program.

Areas typically addressed when identifying guiding principles include the following:

  • Compensation philosophy: Represents the anchor point for compensation decisions (e.g., overarching objectives, market reference points and targeted compensation).
  • Business strategy and objectives: Ensure the design of the long-term incentive program is aligned with the company's short, medium, and long-term financial and strategic objectives.
  • Company growth profile: The design of a long-term incentive program is often very different for a fast-growing company vs. a stable and mature company. Understanding how each vehicle works is paramount to an effective incentive plan.
  • What participants value: To maximize the effectiveness of the long-term incentive program and drive behaviors, participants must see the value of the program. If the plan has no impact, its effectiveness is minimized.
  • Market practice: As a reference point, companies often obtain market data to understand how similarly situated companies address participation, performance metrics, award opportunities, etc. While market practice can help guide decisions, it should not be the overriding factor.
  • Impact of individual performance: Long-term incentives are typically tied to corporate performance, but individual performance can shape award opportunities and participation. The key is to apply individual performance consistently to ensure equitable treatment across the organization.
  • Organizational alignment: The company should discuss if the design of the long-term incentive program should often differ for executives vs. non-executives based on culture, optics, ability to influence outcomes, etc.

Discussions around those seven areas will allow your company to identify the "ideal design" of the long-term incentive program. However, there are often other factors that need to be considered to shape the design of the long-term incentive program. These factors include affordability (e.g., expense limitations, share availability, and headcount), overarching retention concerns that may require the company to temporarily deviate from the "ideal design", external perspectives (e.g., shareholders or stakeholders, proxy advisory firms), and participant communications.

Long-Term Incentive Program Design Features

Once guiding principles and influencing factors are identified, the company can begin to design the long-term incentive program. A discussion of the 4 primary design features is presented below.

Participation: The company should identify an equitable approach to eligibility and participation in the long-term incentive program. In our experience, eligibility should be driven by performance and market data. Questions to ask when assessing the equitableness of participation:

  • Is there an objective set of criteria for determining eligibility and participation?
  • Are employees in a similar level and with similar performance treated in the same manner for both annual and new hire grants?
  • Are certain groups of employees typically excluded? If so, what is the rationale?

Targeted Award Opportunities: Award opportunities are typically derived from competitive data, with the ability to adjust award targets to account for individual performance. In advance of the grant, we recommend companies assess the following from the perspective of being equitable:

  • Are award guidelines aligned with the company's compensation philosophy? If mis-aligned with the philosophy, why?
  • Are employees in a similar level and with similar performance receiving the same / similar target award opportunities? If there is a difference, what accounts for the difference?
  • How does individual performance influence award opportunities? Is the individual performance factor being applied consistently?

Long-Term Incentive Vehicles: As noted, the company's growth profile typically influences equity vehicles granted. We also commonly observe a difference in the types of vehicles granted throughout the organization due to ability to influence outcomes. As your company assesses the most appropriate long-term incentive vehicle(s), the following questions should be considered:

  • Which vehicles are most closely aligned with the Company's profile and strategy?
  • Is the mix being applied consistently?
  • If the mix varies, does it cascade appropriately based on ability to influence results and/or risk profiles?

Award Vesting: Typically, the vesting of an award is relatively straight-forward for long-term incentives, noting that a 3- or 4-year vest is most common. However, the vesting can differ based on a company's facts and circumstances. The following factors should be considered when determining vesting:

  • Is the company's award vesting aligned with market practice? If not, what is the rationale for the difference?
  • Is award vesting equitable across the organization or do some employees / groups receive more advantageous vesting? If so, why?
  • What external factors should be considered with respect to vesting?

Key Takeaways on Long-Term Incentive Program Design

The design of your company's long-term incentive program should be unique to your organization. It should align to your strategic and financial objectives, workforce, financial and share usage expectations, and compensation strategy. Furthermore, it should be internally equitable - delivering similar target compensation opportunities in a similar manner (e.g., mix, vehicles, and vesting) for employees with a similar profile (e.g., level and performance). It is incumbent on us, as HR professionals, to assess the rigor of the long-term incentive program to ensure this is true, and if not, address the inequities.

Competitive Market Data on LTI Design Practices

On the following pages, we have provided competitive market data on how long-term incentive pay practices vary by employee group and across industries. As noted above, market data can help inform the design of your long-term incentive program as it relates to participation, award opportunities and weighting of LTI, and long-term incentive vehicles.

  • Note: Market data is derived from Radford's Global Compensation Database across all industries and based on averages; market data will differ across industries.

Long-Term Incentive Award Participation Across All Industries

A summary of long-term incentive plan participation rates is provided below. Key observations include:

  • Vice Presidents and above nearly always participate in the LTI program due to their ability to influence results.
  • The Technical/Scientific track has higher levels of participation than other tracks.
  • Eligibility declines significantly below the Senior Manager Level (M4), but more gradually across other levels.
  • Participation in the long-term incentive program is heavily influenced by industry, as illustrated in the chart below.

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Long-Term Incentive Award Participation by Industry

To illustrate the differences in participation across industries, the chart below summarizes average participation levels by industry sector. Key observations include:

  • Participation in the LTI program is heavily influenced by industry, with Technology and Life Sciences companies typically extending participation deep in the organization.
  • When assessing the appropriate level of participation in your company, it is important to understand the differences across industries with respect to participation for both the new hire and annual long-term incentive programs.

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Percent of Total Compensation Delivered in Long-Term Incentives

We also analyzed the percentage of total compensation delivered in long-term incentives for various executive and employee groups across all industries. Key observations include:

  • The percentage of total compensation delivered in LTI is typically driven by the ability to influence Company performance.
  • Executives receive a significant portion of compensation in LTI due to their ability to impact Company performance. The highest executive levels receive more than 50% of total compensation in LTI.
  • LTI often represents a smaller percentage of total compensation for Technical / Scientific positions due to heightened cash compensation.
  • For other tracks (e.g., Management, Professional and Support), long-term incentives typically represent less than 25% of total compensation.

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Equity Vehicle Eligibility

Using an all-industry approach, we gathered market data on how the mix of equity between stock options, time-vested restricted stock, and performance shares varies across the organization. Key observations include:

  • Restricted stock is the vehicle of choice for many organizations, as it is straight-forward and tied to the share price.
  • Stock options are still used, but on a more limited basis. The use of stock options is heavily influenced by industry, noting that Technology and Life Sciences companies still typically grant stock options, but practices are also influenced by the company's growth profile.
  • Performance shares are generally limited to top executives that have the largest impact on Company performance.

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7 Tips for Analyzing the Equity of Equity Compensation

Conducting a pay equity analysis on equity awards is more complex than conducting a pay equity analysis of base pay. In this section, we share seven tips to keep in mind as you incorporate equity compensation into your pay equity program.

TIP 1 FOCUS ON THE VALUE OR AMOUNT OF THE EQUITY AWARD ON THE GRANT DATE.

Whether you use stock-based equity, like Restricted Stock and Performance Shares, or appreciation-based equity, like Stock Options and Stock Appreciation Rights, once equity is granted, its value likely will change. While this change in value over time may matter a great deal to your employees-because it directly affects their compensation-what happens to the value of the equity award after the grant date is out of the manager's control.

From a pay equity perspective, we recommend focusing on the value or the amount of the equity award on the grant date for three main reasons:

  1. Straightforward to measure. For example, Restricted Stock and Performance Shares have a known value on the grant date. Similarly, the amount of Stock Options and Stock Appreciation Rights awarded on the grant date is known.
  2. Anchored in a company's compensation philosophy. Your compensation philosophy is your strategic plan for how you make compensation decisions. As an example, a company with a strong pay-for-performance philosophy might grant equity of a specific value for hitting a specific target. There is alignment between the target and value on the grant date. After that, the two may diverge as the award value changes.
  3. Reflects the manager's intention. The value or amount of the award on the grant date reflects the manager's intention in terms of how much to reward an employee.
TIP 2 EXAMINE DIFFERENT CATEGORIES AND TYPES OF EQUITY AWARDS SEPARATELY.

Companies often have different guidelines for different categories of equity compensation. For example, there may be guidelines for new hire equity grants, annual/refresher grants, and retention grants. Since guidelines differ, it's recommended to examine each category of equity award separately.

The same can be said of different types of equity awards. By equity type, we mean Restricted Stock, Performance Shares, Stock Options, Stock Appreciation Rights, and other equity award types.

For some equity award types, the relevant equity compensation metric is the value of the award on the grant date, such as Restricted Stock and Performance Shares. For others, the relevant metric is a number, such as the number of stock options granted, or the number of Stock Appreciation Rights awarded. Since the relevant equity compensation metric differs depending on the type of award, we recommend examining different equity award types separately.

TIP 3 FOR ANNUAL/REFRESHER EQUITY GRANTS, EXAMINE PROPOSED EQUITY AWARDS AND MAKE REMEDIAL ADJUSTMENTS BEFORE FINALIZING.

Base pay is cumulative and can be adjusted at any time to address pay inequities unearthed during a pay equity review. Variable pay, on the other hand, typically re-sets each period. Moreover, it can be administratively burdensome-and difficult from an optics perspective-to adjust variable payouts after they have been awarded.

For these reasons, remediating inequities in annual/refresher equity grants is best accomplished by analyzing proposed equity awards and adjusting these prior to finalizing the award. Under this approach, however, timing is key.

To make this process work, you need to conduct a pay equity analysis of proposed equity awards and make decisions on remedial adjustments in between the time managers enter proposed amounts into the compensation system and the time the compensation system officially closes. For some organizations, the time between these two activities can be as little as a week.

If you expect difficulties aligning your pay equity processes with your other compensation programs, we recommend working with your compensation team to embed your pay equity processes into your compensation programs. To examine proposed equity awards, this may mean extending the program timeline to allow sufficient time to examine and potentially adjust proposed equity awards.

TIP 4 START WITH A FOUNDATIONAL ANALYSIS OF ANNUAL/REFRESHER EQUITY AWARDS.

To analyze proposed equity awards as we outlined in our last tip, an important first step is to conduct a foundational pay equity analysis in advance of your compensation program. For this foundational analysis, you will use your most recent equity awards to conduct the first three steps of a pay equity analysis. As shared earlier, the first three steps are collecting relevant data, segmenting your workforce into Pay Analysis Groups, and, in this case, developing an equity compensation model for each of your Pay Analysis Groups.

Once you've completed this foundational work, you will be able to update the data and re-run the regression analysis using proposed equity awards. You can then identify areas of concern and make remedial adjustments to the proposed equity awards before they are final.

TIP 5 NEW HIRE EQUITY AWARDS AND RETENTION GRANTS NEED TO BE EXAMINED DIFFERENTLY THAN ANNUAL/REFRESHER AWARDS.

Annual/refresher equity awards are generally granted to eligible employees at specific times during the year, enabling the examination of proposed equity awards before they become final. Other types of grants, such as new hire equity grants and retention grants, are awarded only as needed, making it impractical to work with proposed grants for these grant types.

Instead, to mitigate inequities and bias, we recommend putting in place reasonable processes and procedures that managers must follow when making these grants.

For new hire grants, we recommend comparing a proposed new hire grant to the average of recent new hire grants for similar roles. If there is a difference of a certain percentage or greater, such as 10%, ask the hiring manager for an explanation. There are legitimate cases in which you might expect a new hire equity grant to be greater than the norm (e.g., buy out candidate's unvested equity), but it's important to vet these explanations.

When a manager proposes a retention grant for an employee, we recommend asking the manager to explain why the individual is receiving the grant and why other similarly situated employees that report to the manager are not receiving a grant.

TIP 6 USE TECHNOLOGY TO HELP DECISION-MAKERS MAKE EQUITABLE EQUITY COMPENSATION DECISIONS.

Every compensation decision is an opportunity to help prevent, or potentially exacerbate, a pay inequity. Technology can provide decision-makers, such as your managers and your recruiters, with information they need to make fair and unbiased equity compensation decisions.

If implemented properly, software can provide decision-makers with recent equity awards for comparison purposes, equity award guidelines, and a recommended equity award for a specific individual that is aligned with internal equity. This can be particularly useful when equity grant decisions need to be made quickly.

TIP 7 IF EQUITY AWARDS ARE FORMULAIC, ENSURE THE COMPONENTS OF THE FORMULA ARE EQUITABLE.

While it may appear that pay equity need not be considered for cases in which equity compensation awards are formulaic, the formula itself could be subject to bias. If your company's equity awards are completely formula-driven-for example, based on the combination of career level and performance rating-we don't recommend examining the equity of the equity award directly. Instead, we recommend looking for inequities in the formula.

In this example, we recommend ensuring that base salary and performance ratings are equitable, since these completely determine an employee's equity award. Specifically, we recommend running a pay equity analysis to ensure that base pay is equitable and conducting a performance rating assessment to ensure there is no bias in performance ratings.

Caveats About Pay Equity and Total Compensation

Before we conclude, we want to share some caveats about examining total compensation. Organizations often have a total compensation philosophy. While you may want to conduct a pay equity analysis on a measure of total compensation (e.g., total cash compensation, total direct compensation), there are important caveats to keep in mind.

Most notably, a pay equity analysis of total compensation is informational, but not directly actionable. The analysis offers no guidance as to which form of compensation (e.g., base, bonus, equity) needs to be adjusted if an inequity is identified.

It may be tempting to close an inequity in total compensation by adjusting whichever element of total compensation is most convenient. We do not recommend this tactic. For example, if you find that an employee has a $10,000 total compensation inequity, the employee is not indifferent between receiving a $10,000 salary adjustment, a $10,000 one-time bonus, or a $10,000 equity award to close the inequity.

It is particularly problematic to use a bonus or equity award to close a total compensation disparity that is due to a disparity in base pay. An employee's base pay affects more than their paycheck. For example, many organizations match an employee's 401(k) contributions based on a percentage of base pay (e.g., employer contributes $1 for every $1 an employee contributes up to 3% of their salary). Other benefits tied to base pay include life insurance and paid vacation time.

If you'd like to examine total compensation, we recommend examining each element of pay individually and remediating each element separately.

Conclusion

If you're looking for a place to begin, we recommend starting with an analysis of annual/refresher grants and expanding to other forms of LTI over time. Since annual/refresher grants can involve a relatively large fraction of your workforce, you can make substantive progress on addressing inequities in LTI by focusing on this one category of equity awards. As you incorporate LTI into your pay equity program, if you haven't already, we suggest you create a pay equity strategy and corresponding roadmap. One last tip: Good news! The tips we've shared apply to bonuses as well.

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