Be it stock programs, virtual employee shareholdings or long-term incentives that are linked to the share price: they all harbor the potential for discrimination. The compensation experts Gordon Rösch and Dr. Henning Curti from the consulting and auditing company Ernst & Young (EY) explains in an interview when inequalities can arise and why determining the value is not without problems.
COMP & BEN: When do employee equity investments have to be taken into account as part of the equal pay analysis?
Gordon Rösch: According to the EU Pay Transparency Directive, remuneration includes not only basic salaries, but also variable remuneration components and non-cash benefits that are paid based on an employment or service relationship. Since employee equity investments are offered precisely because of an existing employment or service relationship, they automatically count towards remuneration. Although the EU directive does not explicitly mention this component, the underlying broad definition of remuneration suggests that equity programs must be included in equal pay analyses. The German commission for the low-bureaucracy implementation of the directive has suggested that voluntary benefits of value that are not provided by the contract employer, such as a foreign parent company, should not be taken into account in the remuneration analysis. Among other things, she mentioned stock options and phantom stocks. We view this extremely critically, as these employee participation programs are also linked to the existing employment or service relationship and are therefore part of the remuneration.
Are there constellations in which the equity investment does not count towards the total compensation?
Henning Curti: This could apply to investment models outside of the actual employment or service relationship, such as private equity and the venture capital industry. The prerequisite is that the investment can be assigned to a genuine shareholder status and is designed as a performance-based profit share from the management based on the performance of a fund or investment. This primarily serves to distribute results and not to remunerate specific work performance.
What are the risks of pay discrimination in employee share ownership programs?
Courtesy: The potential for discrimination can arise even when allocating shares. This is particularly true if shares, restricted stock units (RSUs) or employee stock options (ESOs) are awarded differently within comparable employee groups. The number of shares granted, the participation requirements or the vesting conditions can have a direct impact on the level of remuneration and thus become relevant for remuneration transparency. Unequal treatment can also occur in the later phase of the inflow or payment. This risk exists not only with share-based compensation systems, but also with any form of variable compensation such as long-term incentives.
What makes performance-based stock ownership risky?
Courtesy: This becomes clear with classic performance share plans. For them, the final number of shares allocated or virtual stock options often depends on the achievement of operational and possibly individual targets as well as on the development of the share price. If the performance of women and men is assessed differently in this context or if target achievement is assessed with different severity, there may be indications of discriminatory remuneration practices.
Gordon Rösch: Contestable criteria result from so-called soft KPIs that are used to evaluate performance. Soft factors such as leadership, potential or strategic contribution create a gateway for unequal treatment. Hard factors, including project lead times, sales or resource efficiency, on the other hand, allow objective comparisons and gradations.
In many companies, only upper management or executives receive shares. Is this approach permitted under the EU Pay Transparency Directive?
Courtesy: Yes, because different remuneration is generally possible. But not within groups of employees who perform the same or equivalent work if this cannot be justified with objective and gender-neutral arguments. For employee participation programs, this basically means that no difference can be made in the allocation between men and women. If an employer stipulates that a share-based participation program, for example, applies to the level directly below the board of directors and direct reports and no other employees take part in it, this is not a problem. However, it must be ensured that the allocation within the mentioned level is measured using the same standards, i.e. the objective and gender-neutral criteria are applied uniformly.
Rösch: With new employee share ownership programs, non-discriminatory implementation is easy. It becomes problematic when shares are granted on a discretionary, personal and inconsistent basis in a program that has grown over time. In these cases, it could be difficult to prove which criteria were used to make the decisions or whether they were really objective. The differences in pay must also be understandable to employees, who will have a right to information. We therefore advise companies to check the structures of their participation programs at an early stage, especially because the data that needs to be prepared and documented is not directly tangible. In many cases, the programs are overseen and managed by external plan administrators.
How is the value of stock options, vesting and LTI terms calculated in an equal pay analysis?
Courtesy: Most companies do not yet have this task on their agenda. But you will have to analyze your participation programs. What is particularly difficult and has not yet been conclusively clarified in practice is how employee equity participation should be valued. While with a classic fixed salary it is clear what amount should be used as remuneration, with stock options and other forms of employee equity participation in which employees receive shares in the company, the question arises: What value should or must be included in the equal pay analysis and the gender pay gap calculations?
Rösch: Another unclear point concerns the temporal allocation of the remuneration, i.e. the annual allocation. Participation programs often run over several years with vesting periods or performance conditions. The question therefore arises as to whether the entire value should be taken into account in the year in which the participation is granted or whether the value should be taken into account when the payment is made.
Which calculation time do you recommend?
Courtesy: When it comes to compensation issues, the fair value at the time of grant is often used: the value of the investment is determined at the time of allocation. However, when it comes to questions about equal pay, this approach falls short. For an appropriate, transparent assessment within the meaning of the directive, what is crucial is what actual payout employees ultimately realize.
Does the German legislature or the EU still need to tighten up to ensure the comparability of employee equity investments within the framework of pay transparency?
Rösch: Yes, from our point of view there is a clear need for further sharpening – both at the European and national level. The Pay Transparency Directive deliberately uses a very broad definition of pay and at the same time remains vague when it comes to practical issues such as share-based employee participation and long-term incentive systems. This applies in particular to the valuation methodology, the time allocation and the handling of performance and market volatilities.
Courtesy: At the same time, it is clear that this is not a simple regulatory project. The great diversity of participation programs and the companies involved – from start-ups to DAX companies – can hardly be squeezed into a rigid template. We do not want over-regulation, but rather a legal framework with clear basic principles that enables transparency and comparability without losing the necessary flexibility.
The legal requirements will initially be missing. What do you currently recommend to start-ups, tech companies, listed corporations and international matrix organizations?
Courtesy: Under no circumstances should you bury your head in the sand and wait for the law. You should start preparing the data cleanly as soon as possible. The effort should not be underestimated.
Salary is an important issue for most employees and managers. Payroll is also a constant task for employers. But the topic of remuneration goes further: remuneration models, salary determination, benefits and additional services, company pension schemes also concern the HR departments. Here you will find numerous news, articles, videos and specials on compensation.
Christiane Siemann is a freelance business journalist and specializes in particular on the topics of Comp & Ben, bAV, labor law, labor market policy and personnel development/careers. She accompanies some human resources round table discussions.
