Fair Pay Act of 2009: Implications for Compensation Modeling - Part 1

The Fair Pay Act of 2009 amends the Civil Rights Act of 1964, and states that the 180-day statute of limitations for filing an equal-pay claim regarding pay discrimination resets with each new discriminatory paycheck. This Act is a direct response to the Supreme Court's decision in Ledbetter v. Goodyear Tire & Rubber Co, which held that the statute of limitations for presenting an equal-pay claim begins at the date on which pay was agreed upon, not at the date of the most recent paycheck.

From an econometric or statistical perspective, the Supreme Court's deision in Ledbetter required that Courts focus on changes in compensation during the relevant class period. The Ledbetter Fair Pay Act, however, shifted the focus from changes in pay to current compensation levels. This act requires the examination of not only compensation decisions made during the class period, but also compensation decisions and "all other employment practices" that affect compensation, regardless of when in the course of the individual's employment such practices began.

So how exactly does one construct a model of compensation decisions? One approach is based on "human capital theory". Using this approach, the econometrician models compensation as a function of the employee's human capital variables, such as education, prior experience and seniority:

compensation = f (education, prior experience, seniority)

The central assumption underlying this model is that, on average, employees should be compensated the same, regardless of gender or race. Under this assumption, an adverse gender or race disparity must be due to "compensation decisions" or "other employment practices" that are applied in a discriminatory manner.

This approach, however, does not allow the identification of any specific compensation decision or other employment practice that created the disparity. Because of this, the human capital approach was often rejected by the Courts prior to the original Ledbetter decision.

Another approach is to construct a model that includes all of the factors that directly determine compensation. Under this approach, the econometrician includes in the model all of the factors that directly determine compensation (the "direct determinants" of compensation). In order to build such a model, it is critical to have a full understanding of how compensation decisions are made. Some common direct determinants of compensation include:

• pay grade;
• job title;
• demotion / red-circling of pay;
• initial penetration in grade when hired;
• time in grade;
• performance ratings;
• past and present subjective assessments;
• department or business segment.

Theoretically , if one had access to all of the data on the direct determinants of compensation and ran an ideal model, one would find that compensation is perfectly preducted by these factors, and that no protected class status variable would enter the model. That is, the model would show no gender or race effects on compensation.

Under these conditions, could one infer that no discrimination exists? No- discrimination may exist either as disparate impact or as disparate treatment.

In Part 2, disparate impact will be explored; disparate treatment will be examined in Part 3.