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Striking the Right Balance for DEI Incentives in Exec Comp

While diversity, equity and inclusion (DEI) initiatives gained esteem at companies in recent years, the social and racial unrest of 2020 brought a more significant development into the spotlight.

Research from Willis Towers Watson revealed that more than half (52%) of S&P 500 companies include at least one environmental, social and governance (ESG) metric in the design of executive incentive plans. When broken down into each ESG measures, social reigns supreme. Within the social component lies DEI metrics, which Willis Towers Watson found in 2020 about 20% of companies in the S&P use as a part of their executive incentive plans. The number is trending up to 23% based on initial 2021 data.

Starbucks, Microsoft Corp., Wells Fargo & Co. and Ralph Lauren were some of the latest notable brands and public companies to announce they would begin tying executive compensation to certain DEI goals. While there’s some tangible evidence that using pay incentives does drive positive DEI outcomes, there’s been pushback from those in the legal community over concerns that this is essentially a form of quota setting, which can open these companies up to discriminatory lawsuits.

Starbucks, for example, revealed in October 2020 that it wants to see 30% of its corporate employees and 40% of its retail and manufacturing workforce identify as either Black, indigenous, or people of color by 2025. The company, which has roughly 200,000 U.S. employees, released internal data that revealed its employee breakdown is 53.2% White, 27.5% Hispanic or Latinx, 8% Black, 5.5% Asian, 4.7% multiracial, and 0.6% American Indian or Alaskan Native.

Starbucks’ announcement came amid the U.S. Labor Department’s review of Microsoft and Wells Fargo’s similarly structured diversity plans. The agency, which was under the Trump administration at the time, asked the companies to explain how their programs to increase Black leadership don’t violate Title VII of the Civil Rights Act that prohibits a race bias.

While a new presidential administration has cooled down the heat from the federal government on the topic of diversity goals tied to executive compensation, organizations’ comp committees and legal teams are still raising concerns over this relatively new practice.   

The Legal Dilemma

The general premise behind financially incentivizing executives to improve DEI at their respective companies is a noble and worthwhile endeavor. Legally speaking, however, organizations can run into issues based on how their program is structured. Title VII of the Civil Rights Act and various state laws prohibits discrimination on the basis of race, color, religion, sex, or national origin. Employers may not engage in policies or practices that, while not intended to discriminate, have a disproportionately adverse effect on minorities.  

Thus, connecting pay with diverse hiring can be construed as creating a financial incentive to hire based on a protected characteristic instead of hiring based on qualifications and other relevant business considerations.

Attorneys have said the threat of “reverse” bias lawsuits might cause companies to reconsider their push to incentivize improved DEI metrics. Overall confusion around the issue since it was challenged by the federal government in October has companies second-guessing themselves.

“Companies were never able to give preference to one race or gender over another. The real result here is that there will be a lot of confusion about reverse discrimination claims,” Tyrone Thomas, a member at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo in Washington and chair of the firm’s Diversity Committee told Bloomberg. “This could have a chilling effect, not because they are violating the law, but because of a large misunderstanding of what companies can do on their own volition to combat racism or sexism in the workplace.”

There is, of course, a business case to be made. Research from McKinsey & Company and the Peterson Institute for International Economics found a clear correlation between gender and ethnic diversity and company profitability. McKinsey’s report found that companies in the top-quartile for ethnic/cultural diversity on executive teams were 33% more likely to have industry-leading profitability.

Julie Levinson Werner, an attorney at Lowenstein Sandler LLP, wrote in Bloomberg Law that the issue might come down to nuance.

“There is a difference between committing to hire and promote a certain percentage of individuals on the basis of their skin color or other factors and committing to interview and/or consider these individuals for hire or promotion,” Levinson wrote. “The Rooney Rule is a commitment, first used by the National Football League, and now by other businesses, to interview at least a certain number of minority candidates for certain positions.”

Expanding opportunities for everyone within all levels of an organization makes sense from a financial, legal, and moral perspectives, Levinson added. However, achieving financial and moral goals in a legal manner requires a tactful approach.

Best Practice

From a legal perspective, Levinson suggests that businesses implement the framework of the Rooney Rule by committing to meaningfully interview and consider at least a certain number of candidates from underrepresented populations. Additional best practices include:

  •        Evaluate methods of recruiting and consider expanding outreach to underrepresented populations by, for example, including historically Black colleges and universities (HBCUs) and a broader range of schools in on-campus recruitment efforts.
  •        Be purposeful and intentional when creating internships, scholarships and other opportunities.
  •        Retain and nurture existing talent by creating training and mentorship programs, which are especially important now with many employees working remotely and feeling isolated and unsupported.

“Adopting quotas of a fixed percentage of individuals in certain roles by a certain date based upon race, gender, or other characteristics, however, is legally risky,” Levinson concluded.

Additionally, organizations should show patience before diving into such incentive programs, said Mike Oclaray, senior director, executive compensation at Willis Towers Watson.  

“Don’t incorporate DEI metrics in the compensation program until the company has made meaningful progress on whatever DEI journey it’s on,” Oclaray said. “Until [the company] socializes the importance of DEI and what the imperatives are internally, and has also started to communicate those imperatives externally to other stakeholders, it shouldn’t occur.”

Once companies have reached that ideal point where instituting a financial incentive program for executives incorporating DEI metrics makes sense, the design of the program is crucial. Oclaray said organizations should “lean in and make DEI a meaningful part of the incentive program” and can do this by making sure it is weighted at least 10%. Additionally, Oclaray said companies should strongly consider making it a part of executives’ long-term incentive plans.

“So far, what we’ve seen is virtually all companies that use DEI metrics put them in the short-term incentive plan,” he said. “But DEI progress takes multiple years. It’s a long road, so it makes sense to put DEI metrics in the longer-term plan.”

Lastly, Oclaray said businesses need to make sure they are truly committed to the DEI portion of incentive plans, otherwise it will result in poor optics for the company.

“Are you willing to pay out dollars on achieving the DEI goals that you’ve set forth even if the financial goals that you’ve set for the same performance period have not been met,” Oclaray questioned. “It’s something that’s worth thinking about from an optics standpoint when you’re thinking about how you’re incorporating DEI in the design of the program.”

About the Author

Brett Christie is the managing editor of Workspan Daily.

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