Is the Balance Sheet Right for Your Expats

September 1, 1998
Consider you’re faced with this scenario: One of your competitors is gaining market share. Your organization’s strategy for counteracting this depends heavily on your French operation running at full speed 12 months from now. Management anticipated this, and sent a team of international assignees from the corporate office to France two years ago. Their objective was to gain an understanding of the European market and to infuse the local workforce with the corporate vision. But from all accounts, you sense there’s little cohesion among the local nationals and the expats in your French workforce.

What went wrong?

A contributing factor could be that the traditional balance sheet compensation plan was a poor fit for your company’s objectives. It’s possible that visible pay inequity between the assignees and their local peers has created bad feelings, thereby undermining morale.

The balance sheet can work well as an expat compensation system, but there are instances in which an alternative would be a better choice. It’s important to occasionally re-evaluate the effectiveness of your policy. Start by looking at the different options for expatriate compensation.

Understand the more popular approaches to expat compensation.
By far, the most commonly used form of expat compensation by U.S. multinationals is the balance sheet approach. As Carolyn Gould outlined in “What’s the Latest in Global Compensation?”, Price Waterhouse’s 1996 survey results show that 92.1 percent of 370 respondents use some form of a balance sheet program. (In the article, Gould discusses Morristown, New Jersey-based Price Waterhouse LLP’s survey results. Following its merger, the company is now PricewaterhouseCoopers.) Of course, this statistic varies from survey to survey, but in general, experts agree that the balance sheet remains the method of choice for U.S. based companies.

The balance sheet was designed soon after World War II as a no-gain, no-loss method of compensating employees for working overseas. The idea is that the employer sustains the employee’s standard of living throughout the assignment, so the expatriate family doesn’t come out ahead or behind because of the international relocation. That’s the definition of a pure balance sheet approach, but in reality, the company usually protects the employee from losing money if the cost of living is higher than in the States, and allows the expat to keep the windfall when the cost of living is lower.

There are two common methods of calculating the balance sheet approach. The home-based method, a term often used interchangeably with balance sheet, bases the expat’s pay on the salary for a comparable job in his or her home city. On the other hand, the headquarters-based method starts with the salary for a comparable job in the corporate headquarters’ city. For example, an expat from a Dallas office of a New York City-based company would receive a salary structured from New York City rates. The same goes for an expat from a London or Tokyo office of the same company.

The question to ask yourself is: Where do I want to see equity? And the answer to this question is closely tied to your global business objectives.

Internationally-based balance sheet systems are less common, and adopt a calculated value for the net income of all international assignees, regardless of nationality. Then, a universal salary structure and benefits structure are calculated from there.

In general, a pure home-based balance sheet calculation of expatriate pay works something like this:

  1. Start with home-based gross income, including bonuses.
  2. Deduct home tax, social security and pension contributions (either a hypothetical tax or a real tax).
  3. Add or subtract a cost-of-living allowance. Usually, companies don’t subtract. Instead, they allow the expatriate to benefit from the negative differential.
  4. Add a housing allowance, either with or without a housing norm deduction.
  5. Add incentive premiums, including general mobility premiums and sometimes hardship premiums.
  6. Add or subtract to equalize taxes. In other words, gross the net salary to protect against the double tax obligations in the home and host countries.

Of course, that can’t be all there is to it. There are also many modified versions of the balance sheet approach and other unrelated compensation systems, including the host-based system. The balance sheet and host-based systems are at opposite ends of a continuum, with many hybrids in between.

The host-based system ties the expat salary to what a local national in a similar position would earn. Basically, the expat starts with a local salary, and then also receives a mobility premium and possibly assistance with home-country benefits. Other terms similar in meaning to host-based include destination pricing and localization.

Now that we’ve dispensed with “Expat Comp 101,” we’re ready to move on to the more interesting part: determining whether your expats should be on a home-based or host-based system -- or something in between -- depending on which group of employees you want your expats’ pay to be in sync with.

Where do you want pay equity?
As you design an expatriate compensation system or re-work an existing one, keep in mind that you have the option of aligning expatriate pay with one of three different groups: expatriates’ home-country colleagues, expatriates’ local colleagues or expatriates’ international colleagues working at the same location. The question to ask yourself is: Where do I want to see equity? And the answer to this question is closely tied to your global business objectives.

  1. Equity with home-country colleagues. The balance sheet or home-based system ties expat pay, as the name suggests, back home. It establishes pay equity between the expats and those in similar functions where the expats came from. The result is a seamless transition when the expat rejoins the company’s workforce in the States. This is why the balance sheet is strong for one-time international assignees.

    Steven Nurney, senior consultant in international compensation services of New York City-based Organization Resources Counselors, explains: “The reason it’s so effective for these finite duration assignments is that it really facilitates the repatriation process. While expats are overseas, their annual reviews [and merit increases] are all tied back to their home countries. The home country compensation structure is the anchor, and everything -- the salary, the benefits -- remains just as if the person stayed back home.”

  2. Equity with local colleagues. Typical American expatriates from U.S.-based multinationals relocate overseas with a rich balance sheet compensation package and settle into expatriate ghettos, isolated upper-class communities. This is especially true when the host-country standard of living is substantially lower than in the United States. But even when it’s not, you can count on your local employees noticing any differences in pay.

    Bill Sheridan, director of international compensation services for the National Foreign Trade Council in New York City, shares his personal experience with this while working for a British employer in the States. “My British colleagues (expats) were living in the choicest communities with the easiest commutes. You pay a premium price for that here in New York City. But back in London, they had been doing the same thing as the rest of us. They were commuting an hour a day in one direction.”

    Sheridan continues, “[Sure, you] recognize the disruption to their lives and [the need for] some concessions. But if expats are living a lifestyle that’s so much higher than they would have enjoyed back in England or wherever they came from, that kind of rubs people the wrong way.”

    And it’s exactly this friction that companies interested in pay equity between expats and local employees are hoping to avoid. Tom Tilghman, a senior consultant with Towers Perrin based in New York City, says: “If you look at the balance sheet, what it really says is: ‘It’s important to us that you continue to live like an American,’ which isn’t like saying: ‘It’s important to us that you live like those you work with.’” In other words, the balance sheet, in some cases, inhibits integration into the host country. So if local pay equity is your objective, consider a host-based system or a hybrid: a local system with a cost-of-living differential.

  3. Equity with international colleagues. Consider internationally based pay as a system for achieving equal pay among the members of your international cadre, or the career expats who sign on for the long haul. If you choose this as your goal, and you have a group of expats of three or four different nationalities working together in Beijing, your plan ensures they aren’t working under several different compensation packages. It also ensures that if two of them accept a new assignment in Tokyo, they won’t be paid any more or less than the expats already working there.

    One way of doing this is to adopt a headquarters-based system. This is like pretending that all of your expatriate employees originated from the headquarters office and are being paid on the same balance sheet program. Or choose a different location -- even a hypothetical city. Inevitably, after several modifications to your adopted base pay rate, you’ll end up with some form of balance sheet hybrid, or what’s considered an internationally-based system.

Choose a plan in line with the purpose of the transfer.
The next step is to determine the purpose behind your company’s expat assignments. Your expat compensation program should support the purpose of the expatriate assignment which, in turn, should support your company’s global business objectives. International assignments tend to fall into a handful of categories. Purposes include:

  • Filling a skills gap overseas
  • Transferring technology and technical skills to the local workforce
  • Developing a fast-tracker’s management skills
  • Transferring the corporate vision to a cross-border location.

Each of these roles demands different job skills and dictates different selection criteria. As a result, each should offer different opportunities and incentives for successful completion.

Here’s where the compensation plan comes in: If your expats are filling a skills gap or transferring technology, these types of assignments usually have a finite duration and a preference for pay equity with employees back home. Your compensation plan simply needs to motivate mobility out and back again. This is a classic balance sheet scenario. These are by far the most common types of assignments as companies work at establishing a strong international presence.

Interestingly, in the past, international assignments were viewed by employees as a quick way to fall off the corporate ladder. Out of sight, out of mind, expats worried that their chances for promotion when they returned home were slim. Sheridan explains that this led expat candidates to demand large concessions within their balance sheet packages in exchange for the risk to their careers.

Sheridan elaborates: “I think it’s getting better today, but for a long time, you didn’t necessarily send the best and the brightest. You sent the adequate and the quiet, and they went off and they did an OK job.” The difference now is that expatriates are more often being chosen from high-potential lists and told that accepting the transfer is a wise career move. Expats are recognizing that the experience abroad will translate into opportunities when they return to the U.S., either with the sending company, or with another organization.

I think it’s getting better today, but for a long time, you didn’t necessarily send the best and the brightest. You sent the adequate and the quiet.

Take this one step further, and you have a few globally minded companies that make it a matter of formal policy that senior executives are chosen exclusively from among those with international experience. In an environment like this, you’re likely to have more than the usual number of interested candidates, so you may not need to employ the traditional balance sheet program. Part of the incentive to relocate is the perceived value of the experience. If your business objectives have evolved to this level, you should also consider a destination pricing system, which is not necessarily less expensive, but can be.

If your expats are developing management skills or are charged with transferring the corporate vision, you have a different set of circumstances on your hands. To begin with, it’s likely that companies with these types of assignments have made a commitment to build a business that isn’t just international, but global. This means that global competition is increasingly significant and corporate objectives include placing more emphasis on growing the company outside the home country than inside.

Companies like this send people all over the world so that executives and managers can learn about foreign markets. These situations certainly challenge the balance sheet. As Tilghman explains, “If the purpose is for you to go to Asia and really understand Asia, then maybe I don’t want to put you in a position where all you’re doing is visiting Asia. The balance sheet [encourages] you to live more like a visitor.”

A point in favor of a host-based or hybrid system with these types of assignments is, again, the heightened level of interest among candidates, especially Generation Xers and other recent college graduates. Director Anders Halden, of the New York City office of Geneva-based Corporate Resources Group, says: “These people are at an age at which they’re not yet bogged down with mortgages, they’re not married, and they haven’t had kids. So it’s much easier to move them around.” Some of these potential expats recognize the value of the experience and take the initiative by volunteering. When the interest is keen, why not go with the least expensive option? You might even consider filling a slot with a host-based expat that you had intended to fill with a local-based employee.

And what happens when the company isn’t really going global, even though the president might think so? This is probably the case in many American organizations. Halden elaborates: “Say you have a manufacturing facility in Kentucky, and you want to send people overseas to help sell your widgets. They’re going to train local people to sell the widgets, and then they’re going to come home. That’s not a global mindset, so forget about a destination kind of package. The less disruptive way is to use the balance sheet in that case.”

Pay close attention to the objectives of your current or proposed expat assignments, and use this information to gauge your company’s true global strategy -- or at least to determine where it falls in the evolutionary process.

So keep an open mind. Re-evaluate your compensation policy as business objectives change, and strive for cost efficiency by working through the calculations under several different models -- because in an era of intense worldwide competition, you can’t afford to send mixed messages to your global workforce.

Global Workforce, September 1998, Vol. 3, No. 5, pp. 19-26.