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Conduct a Pay Equity Study to Mitigate Litigation Risks

T​he Lilly Ledbetter Fair Pay Act of 2009 dramatically increased the exposure of companies to claims of pay discrimination by allowing employees to file a lawsuit for perceived discriminatory pay decisions even if the pay decision occurred years earlier. Similarly, the proposed Paycheck Fairness Act would remove limits on punitive and compensatory damages in pay discrimination cases. These changes come at a time when the Equal Employment Opportunity Commission and the Office of Federal Contract Compliance Programs (OFCCP), federal agencies with pay discrimination enforcement powers, have received substantial budget increases.

Faced with these prospects, what can a prudent company do to manage the risk of pay equity litigation? An increasingly common answer is to conduct a pay equity study. Such a study helps a company understand its pay structure and reduce its potential liability by addressing three questions:

Which pay differences are at issue?

Whose pay should be compared?

What are the factors that explain differences in pay?

Specific and complete answers to the last question are critical. Absent valid explanations, the company is at risk. The key challenge in finding these answers is that, although a company’s pay decisions are made one at a time over an extended period and depend on a variety of factors specific to the time at which they were made, an understanding of pay differences today requires the company to explain the cumulative results of all past pay decisions.

Which Pay Differences: Pay Decisions vs. Pay Levels?

Most companies keep a close eye on pay decisions, such as merit raises and starting pay, and the processes that guide them. Unfortunately, tracking individual decisions might not be enough. Although the Ledbetter Act refers specifically to pay decisions, in many cases the inability to reach into the past for data means that differences in existing levels of pay likely will be used to assess a discrimination claim. In addition, the Paycheck Fairness Act, and the Equal Pay Act that it would update, refer directly to equal pay for the same work. Thus, how employees are paid today—not just the pay decisions of yesterday, or yesteryear—must be examined and understood fully.

Whose Pay to Compare?

The simple answer is to compare the pay of employees who are “similarly situated.” But individuals who are comparable today were not always thus. Given that pay today equals pay at hire plus all subsequent changes in pay, including those from promotion or transfer, employees who today do similar work might, in the not-so-distant past, have worked in different jobs, different grades, different units, different locations or even different companies. Comparing the current pay of employees who were dissimilar in the past means that more historical information may be needed to understand their pay differences.

What Factors Explain Pay Differences?

Differences in knowledge, skill, ability, effort or responsibility provide a legitimate basis for differences in pay among employees doing the same work. However, there are few, if any, direct measures of these factors available, and pay equity studies typically rely on the “usual suspects” to explain pay differences. These include:

Job title or grade.

Time in job or grade.

Part-time status.


Company service time.


Prior experience (as measured by age or time between leaving school and hire).

For employees who have varied work histories, either with the company or prior to hire, these typical factors might be inadequate for complete analysis.

Purpose of a Pay Equity Study

Employers need a richer set of information to explain and defend pay differences effectively. Information that can be collected and analyzed through a pay equity study and maintained at the ready includes:

1. Knowledge, Skill and Experience

Experience, particularly with previous employers, often is crucial to explaining current pay. Some employees developed substantial expertise on prior jobs, while others changed careers or returned from a career interruption. The time someone was, or could have been, working prior to hire is a poor indicator of the knowledge and skill gained from experience.

Action Tip: Starting pay will reflect these differences in experience. Hence it is important to maintain systematic records establishing the reasons for differences in starting pay. Resumes, offer letters and, in particular, records of pay on the previous job can be useful in explaining the differences in pay that are attributable to differences in starting pay.

For positions above the entry level, a pay equity study compares employees who were hired into their current job with employees who were promoted. Even among employees with substantial company service, a pay equity study compares employees who have held positions in a variety of departments or business units with employees who have come straight through. A pay equity study compares employees who previously worked in areas with different costs of living or in different countries. In some cases, demoted employees will be compared with others in the same job or grade. If there have been acquisitions, pay equity studies might compare employees who came from different pay structures.

Action Tip: An employee’s career path is an important driver of current pay. Hence it is important to maintain detailed personnel histories, including those from legacy systems. Previous jobs, grades, departments and locations can be helpful in explaining current pay differences.

2. Ability, Effort and Performance Ratings

A pay equity study compares employees at different levels of performance. Employees with similar current performance might have different performance histories. Among employees who have similar performance histories but work in different departments, previous pay increases might differ because raise pools were different.

Action Tip: Clearly, performance history is related to pay. Hence it is important to maintain individual performance histories as well as information on prior “unit” performance as reflected in raise pools. Performance affects previous pay decisions, which feed into current pay, and the size of raise pools can explain differences in pay.

3. Responsibility and Reporting Structure

A pay equity study, particularly for management employees, might compare individuals who hold the same job title (e.g., “manager”) but who have substantially different levels of responsibility. When job title does not distinguish responsibility levels sufficiently, differences in pay for the “same” job might be substantial.

Action Tip: Pay will reflect the number and type of workers reporting to an employee. Hence it is important to track the reporting structure, including direct and indirect reports for supervisory and management employees. Employees with more direct reports or higher-level direct reports have more responsibility and will be paid more on average. In some cases, other indicators, such as budgets or customer accounts, might provide the measure of responsibility that is reflected in pay.

Undertaking a Pay Equity Study

A pay equity study likely will involve the input of appropriate legal counsel (to preserve attorney-client privilege) and an experienced analyst as well as HR information systems and compensation specialists. The goal of a pay equity study is to develop a statistical regression model that provides an understanding of a company’s pay structure and can explain differences in pay among comparable employees.

A pay equity study is only as good or complete as the information it uses. Most HR information systems include much of the information discussed above, but, in particular, best practices dictate that it is important to:

Recover/preserve at least annual snapshots from legacy systems.

Maintain systematic, electronic documentation for differences in starting pay.

Preserve documentation of historical raise pools by department/business unit.

Using quality data maintained with these best practices, a pay equity study that follows the Action Tips listed above can yield a model that provides a substantially better explanation of pay differences than can an analysis using only the typical factors.

Steps to Take

A pay equity study typically proceeds by:

1. Examining the most obvious (and most readily available) factors affecting pay and assessing how well these factors explain pay differences.

2.When pay differences are not explained well by the factors used, the factors need to be augmented or pay needs to be adjusted.

Detailed analysis of the study results can point to the appropriate response. Examining employees who the model predicts should be paid similarly but who are subject to large pay differences will highlight additional factors that explain the difference or highlight inexplicable differences that merit adjustment.

Repeating these steps—examining employees with similar pay predictions but different pay, and adding factors to the pay equity model and/or adjusting pay—will result in a model that explains the pay structure.

The ultimate goal of a pay equity study is to develop a model that provides an understanding of the company’s pay structure and that explains differences in pay among comparable employees. Conducting a well-designed and well-executed pay equity study using well-maintained and complete data is a good business practice that serves as an important tool in managing the risk associated with allegations of pay discrimination.

Donald Deere is a senior economist with Welch Consulting. He has conducted statistical and economic analysis in cases involving claims of discrimination in employment, housing and insurance, wage and hour violations, and economic damages/business losses. He has conducted analyses of compensation practices for internal and OFCCP audit purposes. Dr. Deere has provided testimony in cases in state and federal courts. His academic research, which focuses primarily on labor markets and public policy affecting wages and employment, has been published in numerous professional peer-reviewed journals, including the American Economic Review, the Journal of Political Economy, the Quarterly Journal of Economics and the Journal of Labor Economics.

Related Articles:

Experts: Design Commission Plans Carefully to Avoid Litigation, SHRM Online Legal Issues, August 2010

Obama, Administration Task Force Call for Enactment of Paycheck Fairness Act, SHRM Online Legal Issues, July 2010

Five Reasons to Focus on PayEquity in 2010, SHRM Online Compensation Discipline, March 2010

3rd Circuit: Ledbetter Law Leads to Equal Pay Victory, SHRM Online Legal Issues, September 2009

Ledbetter Act Adds Lengthy To-Do List for HR, SHRM Online Legal Issues, February 2009

Adjusting to the Ledbetter Pay Law, SHRM Online Compensation Discipline, February 2009

Ledbetter Fair Pay Act Signed into Law, SHRM Online Compensation Discipline, January 2009

Who Gets More: Harry or Sally? Conducting Meaningful Investigations of Pay Equity, SHRM Online Research Articles, July 2006

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