Follow These 7 Steps to an Effective Pay-Equity Audit
Pay equity is a hot topic these days, as reports of gender pay gaps across the country—including within some of the most recognized companies in the world—have caught the attention of state and local government investigators, the Equal Employment Opportunity Commission, the media, shareholder activists, the C-suite and class-action attorneys looking for “the next big thing.” In response, many companies are choosing to proactively conduct pay audits to try to identify and remedy pay disparities. In a few jurisdictions, in fact, carrying out such a self-audit before a lawsuit is filed will provide a complete defense to a pay equity lawsuit under state law.
Pay audits can be very effective tools in the quest for pay equity, provided they are done right. Here is a seven-step plan for conducting a successful pay audit.
Plan Ahead: Set Goals, Get Buy-in and Put the Right Team in Place
The planning stage of the audit is critical. And the first step for any successful pay audit is to identify the purpose or goals of the audit. In some cases, it may be that your company is trying to limit your legal risk and take advantage of a safe harbor under state law. In other cases, the purpose of your audit is to respond to a shareholder demand for a “pay gap” analysis. Or, your company may simply want to ensure that you are paying employees equitably. The purpose of the audit will drive the process and the methodology. Establishing goals at the very beginning of the planning process is vital.
Let’s look at a couple of examples of how the goals drive the process and the methodology.
Federal law requires equal pay for equal work. However, most state laws require equal pay for “comparable” or “substantially similar” work. If the purpose of the audit is to limit risk and ensure legal compliance with state and federal law, identifying which employees perform comparable or substantially similar work will be a key step in the pay audit process. Additionally, there is a growing trend among new state equal pay laws to expand the obligation to pay employees equitably beyond gender lines, and to include other protected categories such as race and national origin. In the recently passed Diane B. Allen Pay Equity Act in New Jersey, for example, there are 13 protected classes, including gender, race, national origin, sexual orientation, age and disability. Once you identify the comparator groups, you can use cohort and statistical analyses to identify potentially unlawful pay disparities as discussed below.
If, on the other hand, your company is responding to a shareholder demand for a “pay-gap” analysis, the process and the methodology will likely be completely different. Often, a “pay gap” analysis identifies the difference between the average compensation of men and women, regardless of position. On the national level, this is the “80-cents-or-less-on-the-dollar” women are reported to make in comparison to men. This type of analysis is particularly useful for identifying opportunity gaps within a company, but would not be the best method to use to identify potentially unlawful disparities between protected classes of employees performing comparable work.
Another key component of the planning process is to get buy-in from senior management. A comprehensive pay equity audit takes significant human and financial resources. It is important that your company develop a budget that addresses the costs associated with data collection and analysis and with correcting potentially unlawful pay disparities. As the president and chief people officer of one of Fortune’s 100 Best Companies to Work for aptly put it when she proposed conducting a pay equity audit to the CEO, the one thing you can’t do is look under the hood, see a big dollar sign, and then shut the hood.
Putting the right team in place to assist with the audit is also an essential part of the planning process. Critical members of the team include human resources personnel (who are familiar with the positions to be examined and the company’s historical and current pay practices), finance or payroll personnel (who have access to compensation data), and legal counsel. It is important to partner with internal or external legal counsel at the onset to try to protect the audit and its findings from discovery in litigation. You and your counsel must put appropriate legal protections and privilege protocols into place at the start of the audit to protect potentially harmful documents and information from disclosure. Legal counsel may also want to retain an economist to join the team early on in the process to build statistical models, perform the pay analyses, and serve as an expert witness down the road if necessary.
Examine Your Pay Practices and Policies
Taking time to examine or re-examine historical and current pay practices and policies is another key step in the audit process, both for purposes of establishing the correct methodology for analyzing pay and understanding and explaining pay disparities. It is important to understand what the various components of compensation are, the criteria relied upon by decision makers in making pay decisions, and how much discretion individuals making compensation decisions have. Experience has shown us that the answers to these questions often vary within organizations by division, department or geography, particularly if your company has grown by acquisition.
Collect the Relevant Data
Once you have examined the components of pay and criteria used for making pay decisions, you must then collect the relevant data for analyzing pay. This data ordinarily includes the following for each employee included in the analysis: job title, department, job grade or level, hire date, gender (and, depending on the scope of the audit, other protected class identifiers such as race), job location, hours worked over the past 52 weeks, base wage or salary, overtime pay, and bonuses or other forms of compensation. Based upon the criteria used for making pay decisions by your company or within the business unit, it may also be necessary to collect such data as performance scores or ratings, level of education (if related to the job), and years of experience in the relevant field or industry. One of biggest challenges for employers conducting comprehensive pay audits is that all of the information used in making pay decisions may not often be captured in HRIS or payroll databases. In such situations, collecting the relevant data can be very time and labor intensive.
Determine Which Employees Perform “Comparable” Work
“Comparable” or “substantially similar” work as defined by state law is broader and more inclusive than the definition of “equal work” under federal law. State law typically defines “comparable” as work that requires substantially similar skills, responsibilities, and effort, and is performed under similar working conditions. Determining whether jobs are comparable requires looking at the job as a whole. While job titles and descriptions may be useful, they alone should not determine comparability. Similarly, do not assume that jobs in different business units or departments are not comparable. It is important to examine if, in fact, the jobs require different skills, responsibilities, and effort, or are performed under different working conditions. Depending upon the state(s) where the employees work, you should also give consideration to other state-specific requirements or guidance for grouping employees.
Analyze the Data
Once the employees are broken into comparable job groups, you can analyze the data. The goal of the analysis is to determine whether men and women (or other classes of protected employees) within the group are paid equally. The methodology you use to make that determination can vary, depending upon the size of group and the complexity of the compensation scheme. For example, for smaller groups of employees with relatively simple pay structures, a comparator analysis of the average pay of men or women (or other protected employees within the group) or a cohort analysis may be sufficient to identify disparities. For larger groups, typically with at least 20 or more employees with at least three comparators in each category (for example, three men and three women), or groups with more complex pay structures, conducting a statistical analysis might be more appropriate. Regression analyses that control for certain variables such as time in job, years of experience or performance ratings are often the best way to identify potentially unlawful disparities.
Assess Whether Differences are Justified Under the Law
Rarely are employees performing comparable work paid exactly the same. However, the fact that men and women or other protected employees are paid differently does not mean such differences are unlawful. To the contrary, there are many lawful reasons for paying employees differently. Under federal law, a differential in pay is justified if the employer can demonstrate that the difference is based on: (1) a seniority system; (2) a merit system; (3) a system which measures earnings or quantity or quality of production; or (4) any other factor other than sex. The fourth justification, known as the “catch-all” exception, was used for decades to defeat claims under the federal Equal Pay Act based upon a whole host of reasons, including salary history. The “catch-all” exception has come under great scrutiny in recent years and is being whittled away by the courts and state legislatures, and the Supreme Court may even interpret this part of the statute in the relatively near future. Many state laws now require that a factor other than sex be bona fide, job related, based on business necessity or that there be no alternative business practice that would serve the same business purpose without producing a wage differential. Massachusetts has eliminated the “catch-all” exception in its entirety. As a result, it is critical to take applicable state law into account when assessing whether pay differences are justified.
When making the assessment, consider whether outliers—employees whose compensation is significantly above or below the average—are grouped properly. In many cases, you will need to re-run analyses as you further examine and refine job groupings as part of the assessment process.
Take Corrective Actions to Remediate Pay Disparities
Where pay differentials cannot be explained by one or more of lawful justifications under federal and applicable state law, you should take steps to remedy the pay disparity. In most instances, this will require your company to make adjustments to compensation. Bear in mind that you may not reduce the compensation of an employee to remedy a pay disparity. Also, when making pay adjustments, consider the timing and, when possible, roll the changes into annual pay adjustments. It is also very important to communicate with hiring managers and others responsible pay decisions about the issues identified in the pay audit and the corrective actions being taken to remedy the problems so that the inequities do not perpetuate.
Sometimes your best defense will be a good offense. That is particularly true when it comes to protecting your business against expensive pay-equity litigation and ensuring employees are paid equitably. Now is the time to conduct a privileged pay-equity audit and take affirmative steps to correct any unlawful pay disparities.