Does traditional pay design accelerate the wage gap? | #eBizInsight | Bryden Morton

The issue of inequality is one that all too frequently finds its way into everyday conversations in all countries around the world. The issue of equal pay between genders (as an example) has been discussed across a number of forums such as Hollywood, the sporting community, in the business community and in academia. The most prevalent world-wide issue of equality is the growing wage gap – this is the ratio of pay between the CEO and the general workers in an organisation.  The exposure of this ratio in the media has brought executive pay into a negative light in many cases. Whether or not the ratio of pay is equitable depends on who you ask, however, one must look at traditional pay design to find how this gap can become larger and larger over time if not controlled.

BizInsight-on-BizRadio-600x250Bryden Morton in conversation with eBizRadio’s Nick von Stein

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Three elements of pay typically make up traditional pay design.

  • Total Guaranteed Package (TGP)
  • Short Term Incentives (STI)
  • Long Term Incentives ( LTI)

Total Guaranteed Package is the value of the fixed pay an employee receives. Short term incentives are performance driven and are designed to pay out within periods less than a year. Long term incentives are designed to drive performance and retain staff over the long term and typically have a vesting period (time to pay out) of between three and five years. Traditionally, the design of an STI and LTI scheme have favoured the higher levels in the organisation as both the percentage of package and eligibility are positively correlated with job grade. Figure 1 illustrates a typical remuneration mix design when using Guaranteed Pay as a base of 100 and expressing STI and LTI as percentage of TGP. The grades have been divided into:

Figure 1 shows how as employees move up through the occupational levels, the percentage of TGP that can be earned in the form of incentives increases as well. The possibility of being eligible to be part of an incentive scheme (both STI and LTI) also increases as job grade increases. The reason for this is that as one moves through the ranks of an organisation, their ability to influence higher level outcomes increases as well.
This leads to variable pay in both the short term and long term often being used to incentivise performance. TGP also shares a positive correlation with occupational level. This ultimately has an inflationary effect on the overall wage gap as the highest level occupations earn the highest percentage of benefits (both STI and LTI) off of a higher value TGP. Figure 2 illustrates South Africa’s national market TGP by grade median.

his illustrates that if the principles of traditional remuneration design are followed (and all performance conditions are met), the Wage Gap increases significantly as a result of variable pay percentages at each occupational level. This is in spite of the STI and LTI being applied to the lower levels of pay uniformly.
This means that the wage gap will continue to grow if performance is met in a company.. According to the Central Intelligence Agency World Factbook, South Africa has the second highest Gini Coefficient Index in the world (estimated at 62.5).
The Gini Coefficient Index is a measure between 0 (perfect equality) and 100 (one person owns all income) which is used to gauge how equal or unequal a society is. The Gini Coefficient is another indication of the Wage Gap but also takes into account unemployed people.
If the same formula is used on South Africa’s formal labour force this number is approximately 0.43. Putting this in context, if South Africa had no unemployed people and the current formal labour market was a true representation of inequality in South Africa, South Africa would still be in the top 50 most unequal societies in the world.

The South African example may be startling, but similar patterns are seen around the world, albeit at varying degrees.
If we, as a society, are serious about reducing the wage gap and becoming more equitable in the labour market and society, perhaps we need to review our traditional remuneration package design principles?
The easy answer would be to apply a flat, standardised percentage to all employees at all occupational levels when designing their incentive schemes but the reality is not as simple. This would fly in the face of Pay design principles of complexity and performance.
At the higher occupational levels, these large incentives and share schemes are often used to attract and retain scare skills – it is about supply and demand. There is no easy answer to this conundrum given the myriad of factors that influence remuneration design.If we are truly striving to more equality in the labour market, alternatives to the current design principles need to be considered.

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