Compversation #4 - The Discretionary Bonus in the Era of Pay Transparency

Is the United States ahead of Europe when it comes to pay transparency?

As early as 2020, a handful of US states were already requiring businesses to disclose salary ranges to employees and job candidates. By early 2023, California and New York had followed suit, giving real impetus to the pay transparency movement. 

It wasn’t until several months later, in the Spring of 2023, that the European Union approved a directive requiring member states to legislate on the issue… giving them a full three years to comply. Of course, this doesn’t necessarily mean that American businesses are more transparent than European ones. 

For one thing, the EU directive is both more recent and more exhaustive. It also manages to avoid certain loopholes which make the US laws easier for businesses to circumvent and, therefore, less useful. 

The biggest of these blind spots? Undoubtedly the lack of regulation around bonuses and other financial incentives. 

‍

Is this the end of the discretionary bonus? 

‍

In the United States, pay transparency laws don’t take into account all forms of compensation: commissions, equity, and bonuses are excluded. Unsurprisingly, many businesses have leaned on these discretionary forms of compensation to reward their best people, retain talent and combat attrition, all while staying within the bounds of the law.

But discretionary bonuses aren’t always used purely as a legitimate way of recognising performance. They can also conceal significant disparities and discrimination. As shown by an ADP study, women receive, on average, less than two-thirds of the bonus amounts paid to men with the same base salary, age, and tenure. 

Before the EU directive was passed, I was expecting to see a similar phenomenon in Europe: more scrutiny on salaries, resulting in greater pay equity around base salary, particularly between men and women. And at the same time, an increase in the types of compensation that fall outside the scope of the law. In other words, a simple transfer of the problem from one type of pay to another. 

But the European directive doesn’t fall into the same trap as the laws we’ve seen across the pond. It accounts for all forms of compensation, including bonuses. 

There’s still some uncertainty around equity compensation: the directive hints that it should be part of the legislation, but in some countries, stock-based compensation has often been excluded from pay discrimination cases. Something to monitor!  This means the EU directive will be more successful in flushing out real disparities in how men and women are treated. This is the whole point of the law: to protect European workers from discrimination. 

But it also poses a thorny question for us, compensation and benefits professionals: how can we continue to reward exceptional performance? 

‍

When differentiating between individuals becomes a risk 

‍

Here’s the problem: the EU directive will reverse the burden of proof for pay equity cases. Once the new rules are in effect, it will be up to businesses to prove that their decisions are equitable. That means every decision employers make will need to be auditable and justified by objective, gender-neutral criteria. 

Businesses will, therefore, be taking a major risk if they decide to reward one employee over others without a justification that would stand up in front of a judge (or other employees). And, since our work in HR is often first and foremost about minimising risk, it’s only natural to wonder whether this new era of pay transparency will lead to a ‘levelling out’ of compensation. Or, even worse, a levelling down. 

Personally, I don’t really believe that transparency will lead to a race to the bottom on pay. However, even if what we end up seeing is more of a move towards the median (as we see when the gender pay gap decreases), the question remains: how can we continue to use compensation to reward exceptional performance? 

‍

Pay equity vs. individual rewards

‍

When the new rules are in effect, more and more businesses could end up taking a risk-mitigating approach. To avoid making anyone unhappy, they’ll distribute bonuses evenly to everyone instead of using them to recognise exceptional performance, which is not always easy to prove or identify. Similarly, they could favour general increases over merit-based, individual ones.

After all, developing effective systems to recognise and reward top performers is a tricky business. 91% of businesses get it wrong, according to Kathi Enderes, Vice President of Research at Josh Bersin Academy. As comp & ben teams, we have two choices: move towards an evening-out of salaries and bonuses, running the risk of losing our best talent (after all, we all know that changing jobs is the best way to get a raise).

Or, accept the challenge thrown our way by the pay transparency era and develop clear, fair methods of individualising pay, while avoiding anything that could be perceived as discrimination. 

Let me be clear: overall, I’m pretty pessimistic. I do think some companies will take the easy way out of this conundrum and favour the satisfaction of most employees over recognition of the few (high performing ones). For those of us that want to retain top talent while remaining uncompromising on discrimination, we’re going to have to put our heads together to find solutions. 

That’s another reason I’m writing this newsletter. 

‍

Let’s keep the conversation going 

Here’s a selection of content to give you food for thought. Feel free to send me articles that you’ve found interesting on this subject! 

‍

Pay transparency and its effect on the gender pay gap — Daniel Wolfenzon, Elena Simintzi, Margarita Tsoutsoura and Morten Bennedsen, CERP.com

Four economists consider the impact of transparency laws in Denmark. While they have reduced the gender pay gap, this has mainly been at the expense of men’s pay. 

The bonus blind spot in US pay transparency — Josie Cox, BBC

The BBC covers the effect that the ‘blind spot’ of US pay transparency laws concerning bonuses and discretionary pay will have on pay equality between men and women. 

‍