From Europe With Strategy: Changing Expatriate Pay Approaches

Michael Ray - Jun 10 2024
Published in: Global Workforce
| Updated Jun 10 2024
As the global workforce evolves, organizational strategies for managing expatriate compensation must also evolve.

Disclaimer: The views and opinions expressed in this article are solely those of the author and do not necessarily reflect the official policy or position of WERC.

Consider the scenario of hiring for an essential role in Singapore and finding the perfect candidate who is eager for the international opportunity. Everyone is excited until compensation becomes a barrier. The candidate declines, citing financial infeasibility, or senior leadership balks at the high cost. This real-life scenario underscores the critical need for effective expatriate compensation strategies.

For global talent leaders, these scenarios are not mere imagination, but a reality they face all too frequently. The challenges of compensating international assignments and transfers are a cornerstone issue in assuring a globally mobile workforce. Today, following trends primarily from Europe, multinationals, including those headquartered in the U.S., are increasingly using alternate compensation strategies for their globally mobile talent to overcome these types of issues. This article aims to delve into why they are doing so, what those approaches are, and the important considerations for using these alternates, all of which are crucial for your role as a global talent leader. 

What Is the Balance Sheet Approach? 

For most of the last 75 years, the basic approach to expatriate compensation has been the “balance sheet” approach. Also known as equalization, a balance sheet seeks to neutralize the financial impact of an international assignment by equalizing the expatriate’s salary and benefits to match those of their home country. The foundations of this strategy are sophisticated financial models developed by balance sheet pioneers such as AIRINC and ORC (now Mercer), which calculate home location costs and compare those to the host location. These calculations then allow the organization to equalize employees with housing, goods and services, and transportation allowances. The whole package is wrapped up in the form of a balance sheet, which includes tax assistance. 

The stated goal of equalization has always been to ensure that the employee neither benefits nor loses financially in the assignment vis-à-vis a hypothetical stay-at-home. As this approach gained popularity in the 1960s and ’70s, it gave rise to a whole industry, including the companies mentioned above, pioneers, tax consulting firms, and technology solutions to administer this process. The financial models driving the balance sheet process also became extraordinarily sophisticated and nuanced, taking into consideration income, specific locations, family sizes, regional spending patterns, and even cultural approaches with efficient purchaser and other models. 

Challenges With Equalization

In 1947, just as the first multinational companies were experimenting with the balance sheet approach, Winston Churchill famously said, “Democracy is the worst form of government, except for all those other forms that have been tried from time to time.” In some respects, the same could be said of the balance sheet. The worst approach, except for all the others! 

This strategy is expensive; it raises the costs of international assignments dramatically, often several times the annual compensation of the employee in question. It takes money, time, and expertise to administer. Companies must purchase the cost-of-living data to support the process. Tax support is usually required to make this work. And it’s a complex process to administer. It’s complicated by split payrolls, compensation accumulation, exchange rate updates, and other variables that are beyond the scope of this article but still give most mobility and payroll leaders migraines. 

Also, despite every attempt to be wholly credible and objective, it can feel like a very subjective process. In the late 1990s, I visited a well-known Silicon Valley company. The international HR rep told me a group of their engineers from Australia were loudly complaining that their allowances were inadequate. Together, we looked at what allowances they were being paid. Housing allowance. Check. Goods and services. Check. Transportation allowance. All good. “What is this number?” I asked. “I am not sure,” she replied. With further investigation, we discovered that these expatriates had mistakenly been paid all of their allowances plus the “total” that had appeared on the cost-of-living report, effectively doubling their allowances. And in their opinion, it was still not fair!

There are many examples of expats making extravagant profits from their assignments, assignees being reluctant to move on at the end of the assignments, and others staying on as expats for many years in the host location, reluctant to part with the rich allowances and assistance provided by equalization. Examples of enormous inequities between local employees and expats are also common. The mid-level expat living in a home the local MD could in no way afford is a familiar example.  

What Trends Have Impacted This Environment? 

For U.S. multinationals, no good alternatives seemed readily available. Without allowances, expats were reluctant to take assignments, and anything short of equalization felt arbitrary and, therefore, led to inequities. 

Yet, European multinationals were finding their way to move talent around the globe without the process of equalization. The establishment of the European Union and the sudden loosening of work requirements between many European countries spurred activity between community countries that defied the need for complex administration. The U.S. is virtually alone in taxing its citizens and permanent residents on global income regardless of where the money is earned or where they are living. Unburdened by this requirement, European companies have long been more comfortable with compensation while on assignments being based on either a host or global model. 

The workforce has also changed. Far from being seen as a sacrifice that needs to be compensated for, many in today’s workforce see an international assignment as a life-changing opportunity to do something different, grow, and experience new things. Employees’ thinking about these things has shifted and, with it, the need to show employees that they will be kept entirely equal or whole is less critical. 

Concerns around the often-extravagant costs for assignments based on a balance sheet approach have put pressure on these types of assignments. Still, perhaps more importantly, global companies are now particularly conscious that the terms of the international assignment or relocation package should consider the why, the purpose, and the driver of the assignment. Career development, a pathway to new skills and experiences, future promotion, or just the opportunity to live somewhere interesting are common underlying reasons for assignments.

“Global mobility teams have always played a key role in facilitating the international movement of talent and connecting employees to opportunities worldwide,” says Max Newbigging, head of global mobility at AON. “Traditional expat pay strategies can be costly, making it crucial for global mobility teams to adopt different strategies. This ensures that employees at all levels have the chance to relocate, helping the organization meet its strategic goals and fostering a globally connected workforce that attracts, retains, and develops talent.”

What Are the Other Approaches?

While the home-based balance sheet approach seeks to maintain an expatriate’s standard of living by equalizing their compensation to match their home country, several alternative methods have emerged, primarily from Europe, each with its own merits and applications.

Host-Based Approach: This method aligns the expatriate’s compensation with the salary structures and cost of living in the host country. It often includes local market conditions and prevailing wage rates. The aim is to integrate the expatriate into the local economy. 

Global Compensation: A global compensation strategy seeks to establish a standardized compensation package applicable to expatriates (and sometimes all employees) regardless of their location. It simplifies the compensation process by applying consistent pay structures, benefits, and incentives across all geographies.

Hybrid: Just as it sounds, the hybrid approach is a mix of compensation strategies designed either to fit specific assignments and individual needs or as a policy across all assignments and locations. Compensation might be a host salary with incremental benefits for the expatriate and tax assistance for U.S. national employees, cost-of-living adjustments that continue for a time, or any number of combinations and permutations. 

If there is a secret in all of these discussions, it is that almost all employers use hybrid approaches to some degree. Pure models are quite difficult to apply to all locations, jobs, conditions, and people everywhere and all the time.  

What Are the Issues With These Alternatives?

The alternate models bring their own set of problems. By definition, a global approach supports a unified corporate culture and simplifies administration but does not always account for local cost-of-living variations. Sometimes, that is a problem, and sometimes, it is not. A global compensation strategy will tend to lead to reluctance to take assignments in high-cost locations and reluctance to leave low-cost areas, all else equal. 

Quite obviously, a host model works best where there is parity between the cost-of-living and pay standards between two locations. It simply does not address the impact of the cost of living on the employee. 

One tool that can be used to evaluate the impact on the employee is what has been called a net-to-net (really a gross-to-net) calculation. This calculation involves determining the net pay an expatriate would receive after taxes and other deductions in both the home and host countries. Some employers use the calculation to ensure that the employee’s net income remains comparable to what they would earn in their home country, adjusted for differences in tax rates, cost of living, and other factors. Creating a pay structure based on the net-to-net is really equalization under a different name. However, this method can provide a clear financial picture for employers and the transferring employee. With appropriate guardrails, it can help companies adjust from the host or global model to create fair and equitable compensation packages.

How Prevalent Are These Strategies Versus Equalization?

The alternate models first applied in Europe have undoubtedly impacted the landscape of expat compensation in the U.S. and globally. Unpublished surveys by cost-of-living data providers show that between 66% and 85% of companies still use the home-based cost-of-living approach for their long-term international assignments. The result may not be surprising, given that respondents to these surveys typically come from the surveying company’s client base, who often purchase COLA data. 

Perhaps a more telling fact has been the decline in volume in the administration of these traditional equalized assignments at mobility companies and tax firms. “The percentage of traditional, tax-equalized assignments has dropped precipitously over the last three decades,” says Brett Sipes, an industry veteran with over 26 years of experience providing mobility tax services at firms like KPMG, EY, and currently GTN. Sipes continues, “In the late 1990s, it was common for over half of a company’s mobile workforce to be authorized for tax-equalized services under a mobility program. In recent years, this percentage of tax-equalized employees has dropped to less than 10% for many companies. A recent trend we are seeing now is that companies are transferring employees to be employed in the host location, even if it is anticipated the employee will transfer back to the original home location within a couple of years or less.”

Another industry veteran, Karen Cygal, CEO and co-founder of Global IQ, shared, “Our research is showing that 60% of companies use a home-based model and 25% use a host-based. Both methods are highly utilized. Interestingly, the percentage of employees relocated under each plan is closer to a 50% home approach and 50% to the other approaches. Host-based is the most prevalent part of this group. It is common to see both approaches deployed within a single organization depending on factors such as the reason for the assignment, the level of employee, and the locations.” Cygal continues, “ As we work into this next generation of mobility, there is a real push for defining equity to an employee as well as across employee populations, and HR professionals are looking at different compensation methodologies and philosophies to refine these strategies.”

Four Must-Haves 

As we move into the blue space beyond the balance sheet, what are the guidelines for deploying balance sheet alternatives and designing expat policies? I have the following four essential must-haves.

  1. Build Stakeholders: In addition to being fiscally imprudent, overly generous compensation and relocation policies build a framework that talks about what “the company will do for the expat.” Instead, a compensation and assignment framework should be built that makes the transferring employee a stakeholder in the success of the assignment. Empowering the employee with choices and the information necessary for these decisions is just one of several ways to do this, even as you move to alternate compensation strategies. 
  2. Care for the Employee: Some hard-charging and budget-focused leaders have seen “alternate approaches” as an open door for cutting costs and gutting benefits. We may not be promising the employees they will be kept whole or equalized, but it remains critical to continue to care for them and their families. International assignments still carry with them particular challenges and risks, and protecting the employee is a critical need, even if you are not striving to keep them “whole.” 
  3. Focus on Transition: Over time, the purpose of long-term benefits tends to get lost, and these become seen as entitlements. In developing a host or global approach, focus on providing those benefits that best help the employee and family transition. They will appreciate the help when they need it most, and by doing so, you are building a sustainable assignment for them and the company. 
  4. Ensure Compliance and Governance: Changing some benefits can have compliance risks. In one case I worked on, the company chose not to tax equalize employees and, therefore, removed tax support from their program. Unfortunately, that led to a significant part of their expat population failing to file their U.S. tax returns. Just as important, organizations should be conscientious in choosing policy approaches and benefits that are in line with their organization’s governance standards. 

As the global workforce evolves, organizational strategies for managing expatriate compensation must also evolve. These alternative approaches are not the right fit for every company’s globally mobile talent, but to remain competitive and effectively support their employees, we must be open to change. 

Michael Ray has over 25 years of experience in talent mobility and global talent management. He has spearheaded international operations for a leading global relocation firm, developed and managed a global supply chain function for a Fortune 100 company, and held senior leadership positions at a global immigration consulting services firm. Currently, Ray leads GlobalMobilityAdviser.com, an independent consulting practice.