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The bonus blind spot in US pay transparency

November 6, 2022
Diversity & Inclusion

There’s one day every year that Matt, a trader at a Wall Street bank, both anticipates and dreads. On this day in January, Matt and his colleagues are summoned – one by one – into their line manager’s office to be told their annual bonus. “It’s an age-old ritual and a huge deal,” says Matt. “In one number, I’m told whether I’ve done a good job or failed.”

Matt works in Manhattan, where pay-transparency legislation is slated to come into effect in November. The New York City-wide law will require employers to include a salary range and position description in each job advertisement. Research shows that women and minority workers tend to ask for less money when applying for jobs, so publishing pay ranges is one strategy that several cities and states have adopted to try to stamp out inequalities.

But the law’s definition of salary does not include all forms of compensation; benefits like insurance are excluded, as are commissions and discretionary forms of payment like the stock and bonuses that make up a sizable portion of Matt’s annual pay cheque. Other pay transparency laws, such as the new legislation in California, also omit these types of compensation from their definition of salary.

In industries like banking, insurance, technology and real estate, significant chunks of compensation are discretionary. So, while human-resource professionals and academics have generally applauded the movement towards pay transparency as a means of remedying inequities, they are also warning of a significant risk: the narrow scope of many of the new laws may actually render them ineffective, because major proportions of people’s compensation are not covered.

And, in industries in which pay gaps are the most dramatic, the law’s bonus blind spot might even exacerbate existing divides.

Only part of the picture

Across the US, a slate of new pay-transparency legislation broadly falls into two categories: laws, like New York City’s, which require transparency at the point of advertising a position; and laws that force employers to publish information on the mean and median salary that they pay certain groups of employees, often broken down by gender and race. In September, California passed laws mandating employers of a certain size to do both.

The latter type of law particularly can provide some evidence for how different groups of workers progress within a company, and whether imbalances – dictated by race, gender or sexual orientation, for example – exist. But neither type can ensure that pay practices are always fair, and that bias is categorically eradicated.

“The law only gives part of the picture on reward,” explains Charles Cotton, a pay and reward adviser for the UK’s Chartered Institute of Personnel and Development, an association for human resource management professionals. “Discretionary payments […] can be a significant part of the overall remuneration picture,” he says, adding that this means that not including anything other than salary may well hinder attempts to level the playing field.

By some estimates, discretionary bonuses can constitute up to half or even three-quarters of total compensation in sectors like asset management, investment banking, private equity and venture capital. At the highest levels, bonuses and other benefits might even be worth a multiple of a base salary. In the start-up world, stock options often make up the bulk of the value of a total pay cheque, particularly in the technology sector.

And it is in industries in which non-salary compensation constitutes a significant portion of overall pay that pay gaps have tended to be particularly large. According to Payscale, a Seattle-based software company that specialises in processing compensation data, male employee earnings currently outpace female earnings across nearly all industries in the US, but disparities were particularly severe in the finance, consulting and insurance sectors.

Where bias thrives

Plenty of research indicates that this relationship between the gender pay gap and the bonus-to-salary ratio is unlikely to be coincidental.

Data from a six-year period to 2016, collated by New Jersey-based HR software provider ADP, found that a disparity in discretionary pay between men and women in equivalent roles exacerbates gender pay gaps. The organisation found the average bonus amount for women was less than two-thirds of the amount paid to men who had equivalent base pay, age and tenure. This disparity, they found, existed across all age, salary and industry groups from the moment an employee was hired through the full-duration of the six-year study.

Bonuses are generally performance-based, and performance reviews are frequently where bias thrives. A 2015 study by Australian consultancy showed men were earning performance bonuses of up to 35% more than women, even when they received the same performance rating. A report by the International Labour Organization, the United Nations agency tasked with setting international labour standards, has also stated that the gender pay gap gets worse when pay includes a discretionary component.

“Discrepancies in variable pay could be, in part, driven by unconscious biases in the performance management framework or other business processes,” agrees Stefanie Coleman, a partner within the people advisory and services team at global professional-services company EY. For jobs in which total compensation levels are determined by commissions, she adds, it could also be the case that the most lucrative leads, or opportunities to generate commission, tend to be directed to well-represented populations – white men, for example – making it tough for workers who belong to minority groups to make it into the highest performance ratings.

Other research, such as work done by Lauren Rivera, a professor of management and organisations at the Kellogg School of Management at Northwestern University, reinforces this idea, showing that individuals tend to give preferential treatment to people who share their own traits and resemble them physically.

A secret weapon

One feature that makes it hard to address the pay gap as it relates to discretionary compensation is that many hiring managers in industries like banking consider bonuses to be their secret weapon for hiring and retaining the best talent.

Banking and tech executives have historically been the most vocal proponents of pay secrecy, arguing that transparency would be a sure-fire way of eroding a firm’s ability to secure top performers. In a corporate culture in which pay secrecy prevails, for example, a manager might be able to use a bonus as a leverage tool to persuade a wavering worker to stay.

In a culture of radical pay transparency, though, giving individual employees huge bonuses risks creating backlash from other workers. Humans are innately averse to inequity, so if they see examples in their own organisation as a function of bonus payments, they could suspect that the rewards system is unfair. Research has concluded that when employees think that they’ve been treated unfairly, they’re more likely to quit.

Brandon Smit, an assistant professor of management at Bentley University in Massachusetts, who has spent many years studying the effects of pay transparency and secrecy, says that there are also psychological reasons why some people might shun an organisation where everyone knows everything about everyone else’s pay.

“We have an innate desire to get along with others and to be seen positively by our peers,” he says. “Sharing pay information, however, can threaten these goals.” Smit explains that, as an employee, if you know you’re getting paid less than a peer, you might feel uncomfortable and regretful. But if you know you’re getting paid more, that’s not necessarily positive either. He explains that under those circumstances you might be fearful of drawing criticism and “perhaps even sabotage from less successful peers”.

In short, there is a risk that exposed discrepancies will create hard feelings on both sides of the equation, and this is a reasoning that resonates with Matt, the Wall Street trader. “Privacy around pay is so ingrained in the culture of banking, and I can’t imagine that ever changing,” he says. “If everyone knew what the person next to them was making, half the bank would probably quit.”

No sign of broader legislation

So far, there’s no sign of any real legislative effort to broaden the scope of pay transparency laws in the US. To comply with laws requiring salary ranges to be published in job advertisements, employers in Colorado and Washington must include a description of other perks and benefits, which include stipends, bonuses, retirement programs and insurance offerings. But the exact size of those components does not have to be stipulated.

In the UK, gender pay gap reporting legislation does require companies with 250 or more employees to publish their mean and median bonus gender pay gaps as well as the proportion of men and women receiving a bonus as part of their overall pay. But there are no requirements in the UK for publishing compensation ranges alongside job advertisements, and mechanisms for checking the accuracy of either salary or bonus pay gaps are imperfect. In 2018, a year after the UK introduced gender pay gap reporting mandates, an investigation by the Financial Times showed that one in 20 gender pay gap reports were statistically improbable and therefore likely to be inaccurate.

As such, EY’s Coleman says companies wanting to address and remedy pay gaps should instead concentrate on embedding controls within their performance management frameworks “to help limit the effects of unconscious bias in the determination of discretionary compensation outcomes”. They should, for example, review performance ratings and bonus outcomes as part of the year-end process “to identify any concerning patterns in relation to minority populations”, she says.

“Companies’ HR departments should be regularly benchmarking compensation to assess whether adjustments need to be made,” agrees Julia Lamm, a partner in the workforce transformation team at PwC.

And that’s something that Matt can support, too. “I personally don’t want to talk about how big or small my bonus is, but that doesn’t mean I want my company to discriminate,” he explains. “Companies should do the right thing, treat people fairly, know their numbers and pay their employees what they deserve. It really is the very least we can expect from our boss.”

By Josie Cox


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