Editor's Note: Back by popular demand and ongoing inquiries, here is Jim Brennan's Classic advice on the application of geographic salary differentials to executive pay.
Pay varies by geographic location. Executive positions, however, tend to be treated differently, for a variety of reasons.
Wages and salaries for the same job have different competitive levels in other cities. The degree of pay difference from a national norm also varies by income level, with entry positions showing the greatest sensitivity to local practices, particularly in places that override the federal minimum wage. Low-income workers are typically tied to jobs close to their homes. Professionals and managers tend to be paid on a regional basis, since they are more apt to commute farther or to be recruited away by nearby rival employers; that drives up the area rate to a higher more stable equilibrium point for their jobs. Directors and top executives operate in a national (if not international) job market for their talents. Local competitive market conditions for jobs tend to create pressures for companies to pay whatever is right for that particular place; but many employers hold their executives to a different (usually national) common standard rate.
Location does make a difference, even in top executive compensation. Researchers who have studied this for over forty years1 see geographic pay differentials continue up into top executive levels. All else being equal, executive pay still varies by geographic location. Chief executive officers at same-sized hospitals in California earned 25% more than their peers in Indiana, for example.
Most employers with multiple locations have some salary structures that vary by area, but those variations don’t usually apply to top officer pay. It is rare to see an enterprise with formal geographic differential policies in effect extending all the way up to the executive officer level.
There are many reasons why employers don’t pay all jobs according to the local pay pattern.
In the federal government, jobs paid according to the General Schedule can earn localized pay, but the geographic variances stop at the Senior Executive Service and the Executive Schedule levels. Private employers do much of the same. If a company has separate pay by location, the geographic pay differences are usually greatest at the lowest levels where the entry jobs are affected by the minimum market-clearing wage rate. Employer area pay practice variances tend to change at different job levels, but, typically, the differentials taper off and stop at some level.
The theory behind the conventional practice is that if you are recruiting in the national labor market for a particular job level, then you should be using national pay scales. And if you are recruiting from local or regional labor markets for a particular job level, you should be using local or regional pay scales. That common-sense approach argues that companies should limit their special location-specific pay scales to cover only jobs filled by people expecting local rates; those expecting national or even international pay levels can be treated differently and local competitive variances may be ignored.
Even though the actual proofs of geographic pay differentials extending through CEO levels beyond $500,000 are indisputable2, most employers don't choose to capture the reality with a separate offset to their top executive salary structures as they do for lower levels. It just isn't worth the trouble, particularly when the executive total comp packages are so large and complex that the influence of any one component variable can be hidden or overshadowed by many others. Nevertheless, the reality remains true: even at firms of identical size in the same industry, executives working in Manhattan earn a lot more than they do in central Kansas; but most organizations find it more appropriate to exclude senior executive jobs from geographical pay differential programs than to call attention to an additional premium added to jobs already paid premium rates. That would appear excessive.
It really makes little difference to most top executives, since most work in big cities where the “national scale” applied to their positions is quite competitive. In fact, basing national pay on the headquarters competitive market tends to create excessive overpayments when those big-city metropolitan rates are applied to subsidiaries in lower-paying areas. Few CEOs of major firms are employed in the small towns or rural areas where pay differentials tend to be low.
Besides, when companies decline to apply geographic pay differentials to top executives, it makes them look modest and conservative; and they certainly need to burnish that image as much as they can.
1 D. Thomsen, “Geographic Differentials in Salaries in the United States,” Personnel Journal (Sept. 1974): 670
2 D. Thomsen, ERI Update, (Vol. 76, Oct 2006): pg. 3, bottom
E. James (Jim) Brennan is an independent compensation advisor with extensive total rewards experience in most industries. After corporate HR posts and consulting CEO roles, he was Senior Associate of pay surveyor ERI before returning to consulting in 2015. A prolific writer (author of the Performance Management Workbook), speaker and frequent expert witness in reasonable executive compensation court cases, Jim also serves on the Advisory Board of the Compensation and Benefits Review.
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