Does Discretionary = Discriminatory?

ESG (Environmental, Social, and Governance) goals have become the rallying cry of investors and board advisors. DEI (Diversity, Equity, and Inclusion) goals remain a key issue for Human Resources professionals. At many companies, there is still a widespread allowance for discretion in setting pay levels, variable compensation incentives, and equity compensation awards. Discretion is a precarious thing. It allows companies to recognize great talent or performers, while at the same time allowing for potentially discriminatory practices. Getting your arms around this topic may save you from a load of hurt in the future.

Most leaders and talent acquisition professionals want the autonomy to negotiate with prospective employees. This gives them the ability to create the best value proposition for both the company and the individual. The majority of HR and compensation professionals seem fine with discretion and many do not have a formal review process to ensure the final offer rationally fits within the pay structures of the rest of the company. Unfortunately, I have seen base pay numbers that range from $60K to $200K for the same role! So much about total rewards depends on the foundation of Base Pay. When the foundation is so differentiated, it is nearly impossible to have other pay elements make sense.

It is still a common practice for companies to offer discretionary “bonus” programs. These programs often fail at their intended purpose. The lack of transparency means that differences in amounts can seem like they are based on favoritism (and they often are.) The programs also suffer from “recentism”. Work done in the most recent quarter is unconsciously weighted more heavily than worked performed earlier in the year. Like a kid who does all of their homework the last week of the school year, this allows people to work hard and campaign during “bonus season” and be rewarded like they did great all year. Combining something that may not seems fair with an ability to manipulate results seldom creates a satisfying result.

When you add equity compensation as a pay element the results skew even worse. People like round numbers, so grants under up being in round numbers. How much more can 2,500 shares deliver than the standard 2,000? Using Amazon as an example: In 2016 Amazon stock was around $1000/share. Today it is about $3,200/share. 500 additional shares would have created an additional $1.1M over the last five years! An extreme example, of course, but not that extreme when compared to the relative changes in values between an early-stage pre-IPO company and the same company after its IPO.

Here are some things you can do to get started.

1. Limit the level of negotiation and discretion for Base Pay. This is true for pay above and below your target amounts. Just because you can hire some for far less than the market, doesn’t mean you should. Unless paying below market is a common practice for your company, it is likely to result in an unfortunate dispute in the future.
2. Put more structure into your annual bonus programs. Educate your managers on how they can and should use their budget. Perform peer reviews or approvals to ensure that bonuses aren’t based on relationships or recent activities. Consider creating a real Short-Term Incentive plan with measurable goals and related payout levels.
3. Be far stricter about equity award sizes. Provide strong, understandable guidelines. Make sure everyone involved understands the potential impact of a differentiated grant. Scale standard award sizes to flatten differences in base pay for the same job level.

Without an underlying current of ESG and DEI concerns unchecked discretion has been a real problem for as long as people have been paid. With the overarching goals, audits, and visibility that come with better governance and concerns about discrimination and fairness, unchecked discretion is a time bomb waiting to ruin an upcoming year for you and your company. Getting ahead of it before the new year should be a goal for everyone in Human Resources and Compensation.

Dan Walter is a CECP, CEP, and Fellow of Global Equity (FGE). He works as Managing Consultant for FutureSense. Dan is also a leading expert on incentive plans and equity compensation issues. He has written several industry resources including a resource dedicated to Performance-Based Equity Compensation. He has co-authored ”Everything You Do In Compensation is Communication”, “The Decision Makers Guide to Equity Compensation”, “Equity Alternatives” and other books. Connect with Dan on LinkedIn. Or follow him on Twitter at @DanFutureSense.

Comments

[E. James (Jim) Brennan]

"Discretionary" generally means voluntary, not subject to a fixed set of rules nor pursuant a pre-established formula which must be followed. It permits the exercise of judgment rather than compelling precise adherence to an objectively fixed procedure.

None of that guarantees perfection, excellence or "fairness" of any kind. Remember that equity usually implies identity while fairness simply means "what I want".

Dan is completely correct that discretionary can be discriminatory: unconstrained choices will usually involve distinctions based on subjective criteria. Teaching supervisors how to manage performance is ALWAYS a good idea... even if it does not guarantee perfection.