Caution Advised: Use of DEI Performance Goals in Incentive Compensation
Thursday, October 19, 2023

Recent court decisions have ruled that certain race-based college admissions programs violated the Equal Protection Clause of the Fourteenth Amendment of the U.S. Constitution. While these decisions do not apply directly to private employers, some observers expect them nevertheless to encourage more scrutiny of affirmative action policies or practices in the private sector.

Discrimination and Incentive Compensation

One area in which this heightened scrutiny could be focused is incentive compensation programs, which in recent years have increasingly included elements relating to environmental, social and governance (ESG), and diversity, equity, and inclusion (DEI). Employees, job applicants, politicians, shareholders and activist groups may view these elements as instances of “reverse discrimination” and seek to bring claims on that basis.

Legal Requirements

Title VII of the Civil Rights Act of 1964 generally prohibits employers from discriminating on the basis of race, color, religion, sex or national origin. Some states and local jurisdictions have enacted additional prohibitions against discrimination by employers.

The Supreme Court has held that Title VII does not prohibit certain types of affirmative action, and the EEOC has published regulations intended to address the use of affirmative action and employer use of affirmative action plans under Title VII. See 29 C.F.R. Part 1608. Under these regulations, employers engaging in race-conscious or gender-conscious employment decisions must:

  • Maintain a written plan.
  • Conduct a reasonable self-analysis of the relevant employment practice that provides a reasonable basis to conclude that the practice has had an adverse effect on previously excluded groups or groups whose opportunities have been artificially limited.
  • Have reasonable action in the plan that is narrowly tailored to solve the problem identified without placing unnecessary restrictions on the entire workforce.
  • Not maintain the plan any longer than necessary to achieve the plan’s objective.

Past judicial decisions in this area have focused on, among other things, any connections between compensation decisions and the achievement of DEI goals (including good faith efforts goals). Because incentive compensation programs inherently involve compensation decisions, companies should be careful about using a structure under which achievement of DEI goals affects the amount of compensation earned.

Programs that encourage efforts toward broader initiatives, such as investing time in outreach to more diverse candidate pools, will likely involve less risk of liability than programs involving goals that impact individual employment decisions or that tie performance ratings and compensation decisions to numerical or otherwise objective outcomes. A program that ties compensation to maintaining a quota, such as a number of positions that will be filled by diverse candidates, may be more problematic than a program that ties compensation to an executive’s efforts in seeking out a broad group of candidates for leadership training.

Next Steps

To minimize the possibility of claims of unlawful discrimination relating to their incentive compensation programs, employers should consider reviewing their programs to ensure they do not violate the restrictions of Title VII or other applicable law.

A potential action plan for beginning such a review is below:

  1. Identify all incentive compensation programs that have included or that could in the future include non-financial performance measures. Common examples include annual bonuses with strategic or personal goal components.
  2. Categorize the performance measures that have been or could be used under the programs. A typical example would be performance measures relating to diversity in hiring or promotion.
  3. Identify any overlap between those performance measures and the Title VII and other protected classifications (e.g., race, color, religion, sex or national origin).
  4. Determine the extent to which there are quantitative goals attached to the overlapping performance measures. A common example would be a goal for increasing diverse representation in specific roles within the company.
  5. Publicly-traded companies should review their disclosure in their proxy statements, ESG reports and other public-facing documents for any statements that could be seen as connecting performance goals under incentive compensation programs and protected classifications in a problematic way.

Employers should work with their legal advisors to ensure that they have identified all relevant legal requirements and to structure their review of their incentive compensation programs to maintain attorney-client privilege to the extent possible.

 

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