CHAPTER 6
COMPENSATION TERMINOLOGY AND CRITERIA

“The beginning of wisdom is the definition of terms.”

—Plato

Based on Plato’s quote, it seems appropriate to begin our discussion of compensation systems by explaining general terms common to compensation systems. This chapter discusses not only compensation terms, but also the criteria many firms currently use for evaluating performance.

COMPENSATION TERMINOLOGY

In this section, we define and discuss four key components of owner compensation: base pay, return on capital, bonus, and return on equity. We also explore the concepts of total compensation.

Base Pay

Base pay can best be defined as the pay for a job or position excluding additional payments or allowances. The difficult questions include:

▮ What is the base value of any given position?

▮ How much should you pay?

▮ How do you determine what the pay should be?

These are merely some of the questions owners of public accounting firms and human resources professionals ask themselves consistently when hiring new employees or admitting new owners.

For most workers (with the exception of C-level executives such as CEOs, CFOs, and CIOs), base pay is the essence of their compensation. This is historically true for owners of public accounting firms. As we look at a typical accounting firm, base pay is often determined by position. For each position in the firm (for example, staff accountant, senior, supervisor, manager, and director), firms generally create a base-pay range that is often determined by market pressures, applicants’ years of experience or negotiation skills, and a list of other criteria that may or may not have anything to do with what it takes to get the job done.

Profession Averages

Exhibit 6–1, “Robert Half 2006 Public Accounting Salary Statistics,” outlines selected statistics from the Robert Half 2006 Salary Guide. According to this guide, public accounting salaries ranged from $42,750 to $60,000 (large firms), to $36,750 to $46,000 (medium firms), to $35,500 to $42,500 (small firms) for individuals with 1 to 3 years of experience. Individuals with a master’s degree or CPA certification earned up to 10 percent more.

Starting salaries for owners in public accounting firms averaged around $175,000 and rise well into the six-figure and even seven-figure range depending on experience, size of the firm, and overall profitability. Directors can expect salaries of $85,500 to $130,000 (large firms), $76,750 to $111,000 (medium firms), and $71,500 to $90,250 (small firms). Managers can earn salaries of $70,250 to $95,000 (large firms), $66,500 to $83,250 (medium firms), and $60,000 to $72,500 (small firms).

Importance of Base Pay

Base pay is especially critical among owners in a firm because it sets up a formal or informal pecking order. An individual’s base pay often signifies his or her value to the organization. Most owners refer to their base pay as a draw or salary. We find owners tend to pay more attention to what they get paid in comparison to another owner (relative pay) than to the actual dollars they receive (actual pay). We have witnessed countless cases in which Owner A is upset because Owner B is paid $3,000 more when, in fact, each owner is paid well over $300,000.

Base pay for most accountants is the largest portion of total compensation. This is a fundamental cause of a number of compensation issues faced by accounting firms today. A disproportional percentage of base pay tends to create a system of entitlement and makes change harder to implement.

In Paying for Performance, Peter T. Chingos points out several instances in which base pay may become too cumbersome for proper performance and rewards, including:¹

▮ Too much focus on base pay as the primary element of compensation

▮ Too much effort on cheating the system

▮ Too little education on what is required for performance increases

▮ Too little emphasis on contingent compensation as a motivator

Ed McGaughey, Director, KPMG’s Performance & Compensation Consulting Practice notes that “basing pay on wage trends or cost of living, as opposed to value creation, will most often limit accomplishment of strategic pay objectives.”²

Current Methods for Calculating Owner Base Pay

Not too long ago, we asked a handful of managing owners the following three questions:

1. Do you have a minimum level of compensation for a new owner? If so, how is it determined?

2. Do you determine the market value (street value) of your owners?

3. How do you determine new owner compensation (for example, formula and gut feeling)?

While this was not a statistically valid survey, it does give a flavor of what firms are currently doing. Here are some of the replies.

“Our first-year owners start at $131,000 (and the base gets adjusted each year for inflation), and merged or acquired owners come in at a rate similar to what they were making. Our draws get increased (for inflation) each year for the first eight years until the base draw is $210,000. Our target for base draw as a percentage of total owner comp (firm-wide average rather than by individual) is a maximum of 50 percent. This year, we are at 49 percent.”

“At this time, we do not have a formalized minimum level of compensation. I would say that, informally, we have used the $125,000 range.”

“We determine the initial compensation based on the following relationships: (1) billable hours, book of business, or technical specialties; and, (2) if it is a lateral move, we add ‘what it would take to get him or her to join the firm.’”

“If someone is coming up internally, I would look at the spread of what they were making as base pay as a manager to their base pay as an owner to make sure it is worthwhile. My recent base was $125,000. If an owner is coming in via a merger or acquisition, I would make sure the total package is more than what they were receiving previously.”

“We have never considered ‘street value’ of an owner, but we do keep an eye on the various firm surveys to ensure our owners are compensated similarly to firms of our size in markets that are similar to ours.”

“We are moving in that direction [that is, toward street value].”

“On an annual basis, I look to see if base pay should be increased, based on both public and private pay benchmarks.”

Even though the above was not meant to be a scientific study of determining base pay for owners, it does suggest that many firms have no objective or systematic approach for determining base pay.

An Objective Approach to Base Pay

Nicholas J. Mastracchio, in Mergers and Acquisitions of CPA Firms: A Guide to Practice Valuation, provides a formula to determine the fair value of an owner’s services.³ Mastracchio’s assertion is that the money owners take out of the firm is a combination of both a fair compensation and a return on their ownership investment. He believes that if the firm (1) has a simple or complex compensation formula for owners that identifies and values key criteria (for example, billable hours, new business, and client service), (2) quantifies each criterion as salary before equity distribution, and (3) has a process and results that are reasonable, then fair compensation has been identified.

One could definitely argue about the reasonableness of many compensation processes. For those firms that do not use the above approach or do not know what fair salaries should be and do not want to estimate them, Mastracchio provides the following formula that can, at least, serve as a starting point for further discussion about fair salaries for owners.⁴

His formula is based on the salaries of others in the firm, mainly managers and directors. Staff salaries (A) are to staff billing rates (B) as owner salaries (C) are to owner billing rates (D). Think of the following equation:

The calculation is based upon a ratio of known facts. Firms have information about A, B, and D. Having this information, they can then solve for C (owner salaries) as follows:

(Staff Salaries × Owner Billing Rates)/Staff Billing Rates = Owner Salaries

For large firms, Mastracchio suggests using manager and senior salaries, and for small firms, he believes full-time professional staff salaries can be used.

Consider a hypothetical large firm. If the average salary for managers is $85,000, average manager billing rates are $143. This assumes the firm calculates billing rates by dividing the employee’s fully loaded cost by 2,080 hours and then multiplying that amount by 3.5 (assuming $85,000/2080 times 3.5 multiple). By assuming that the average owner billing rates are $225, owner salaries would be calculated as follows:

($85,000 × $225)/$143 = $133,741

Under this hypothetical example, $133,741 is a fair base compensation for an owner in the firm. Any amounts paid over $133,741 would be considered a bonus or a return on ownership interest. While this method is not without issues, it can provide a starting point for determining a fair base compensation for owners.

Return on Capital

If a firm requires its owners to make a capital contribution, the firm usually pays interest on the owner’s accrual capital account. Some firms pay a fixed percentage while others pay from one to three percentage points over prime. This portion of an owner’s compensation is usually paid monthly to the owner and is paid before any bonuses or return on equity.

Owners are making greater investments in technology, real estate, and marketing than ever before. It may seem that new owners and even existing owners only want to take money out of the firm. They often find it hard to think of a practice like a real business in which assets are bought, people are paid salaries, and investments are made for the future. So, a few years ago, we asked several well-known consultants such questions as, How much accrual basis capital should a firm maintain? What are you seeing in the market today? How are firms determining capital accounts? What’s the rationale behind their methods, and how are owners coping with keeping more money in their firms?⁵

Don Scholl responded, “No matter if the firm is a sole practitioner or multioffice, multiowner entity, each firm should require some capital to fund its working capital needs and any capital requirements for equipment and property. I have always felt that, at a minimum, capital accounts should be 20 percent of a firm’s budgeted collections. This minimum anticipates that the firm will be using its line of credit for some part of the year. Further, there is a positive element about having a low capital requirement. It can force the owners to become aggressive in collecting accounts receivable.”

Marc Rosenberg felt that “sophisticated firms will set a target for capital. The most common target is a percentage of net fees, usually 20 percent to 30 percent. But the vast majority of firms are not this formal and do not set any target for capital. Capital is as it is. The key, from a cash flow or capital-planning standpoint, is to avoid paying compensation to owners before WIP and A/R is collected.”

Chris Frederiksen added, “I’ve seen a few firms go as high as 50 percent of fees. But that is surely not the norm. In any case, the capital should at least equal the net income of the firm before any owner compensation. With regard to Don Scholl’s comment, I would recommend to a million-dollar firm with net income of $350,000 to have at least that $350,000 in capital.”

Bonus

Bonuses are normally paid to owners after the return on capital has been paid. Bonuses can range from 10 percent of base compensation to more than 100 percent. We are familiar with firms in which owners can receive from two to three times their base as a year-end bonus.

For bonuses to be effective, we suggest they be substantial. An owner whose base compensation is $300,000 may not be motivated to make significant effort during the year for a $20,000 or $30,000 bonus because it does not significantly change his or her lifestyle. We believe bonuses should be at least 20 percent or more of the base compensation to be meaningful.

The basic purpose of a bonus is to reward performance beyond expectations. In our minds, extraordinary performance means doing something beyond what is expected. It’s like hitting a grand slam. If owners must debate whether performance was extraordinary or not, it probably wasn’t.

Another purpose of a bonus is to reward extraordinary performance for both owners and employees without increasing base compensation and thus facing the possibility of paying for mediocre performance in subsequent years. We believe it is better economically for a firm to provide bonuses to employees rather than inflate base salaries needlessly.

Return on Equity

In many firms, there is no relationship between an individual’s capital account and his or her equity in the firm. Some firms have a minimum capital contribution requirement, and equity is merely allocated to new owners.

Equity payments are often considered as entitlement payments because they have nothing to do with current performance. Only 28 of the 423 (or 6.6 percent) firms that responded to the 2006 Compensation Survey use a pure ownership percentage method as their owner compensation system. All 28 of these firms except 1 are under $5 million in net fees. The exception is between $5 million and $10 million. Of respondents who use the ownership percentage method, 67 percent believe the system is designed not to be fair or to be only somewhat fair.

The reason for the lack of fairness is obvious. Owners with larger equity percentages reap the benefits from other owners who may be doing more work and bringing in more new business. Only a strong-willed managing owner with high equity can keep this system alive. The other owners in these firms often operate as senior managers and are given little opportunity to provide input into the management or direction of the firm.

There should, of course, be some return for ownership as a percentage of total compensation. While it currently varies from firm to firm, we believe it should generally be between 15 percent and 20 percent. If the firm pays an ownership dividend, it should be paid after owner draws, bonuses, and returns on capital have been paid.

As our 2006 Compensation Survey showed, most firms today realize there is little, if any, correlation between equity and compensation. There are two times when equity does become important. First, when the firm is sold and owners distribute the proceeds of the sale. Second, when an owner retires and the retirement formula is based on the equity percentage.

When we asked members of the New Horizon Group about how a firm decides how much ownership (equity percentage) to assign to a new owner, we received an array of answers.

For example, Marc Rosenberg responded that “this is one of the most comical and haphazard areas of CPA firm practice management. Most firms, if they were honest, would admit that there has been no coherent or consistent system used to determine ownership percentage. This is a big mistake because if ownership is used in important ways, like allocating income or determining retirement benefits, it will make the owners very unhappy when the inevitable arises (an owner with a high ownership percentage is awarded compensation or retirement benefits that are far in excess of what he deserves).”

Bob Martin cautioned everyone “to remember that ownership percentage has an impact on owners in five possible ways: (1) voting, (2) compensation, (3) retirement benefits, (4) determining buy-in amount, and (5) allocating assets and liabilities from the sale or liquidation of the firm. But the impact and influence of ownership percentage can be eliminated in all but number 5.”

Steve Erickson thought that “the larger the role that ownership plays on the above, the more problems and complications you will have. Conversely, if you minimize the role of ownership percentage, it makes it easier to bring in new owners and deal with each of the above areas separately.”

And Rita Keller felt that “when it comes to compensation, it should be allocated primarily on the basis of performance, not ownership. However, there are still a lot of small firms paying senior owners on ownership.”

Don Scholl had a different take on the question: “Buy-in should be determined not by ownership percentage but by what the current owners feel is a meaningful number they want each new owner to contribute. For example, take the case of a four-owner, $3 million firm with capital of $1 million. If you admit a fifth owner and want that person to be a 5 percent owner, that would result in a buy-in amount of $200,000, which today is considered by most firms to be higher than what young people are willing to pay. The firm is better off deciding on a meaningful amount, say $50,000, and working backward to decide on the ownership percentage. In this case, the new owner would own 1.2 percent of the firm [50,000 divided by 4,050,000].”⁶

TOTAL COMPENSATION

Total compensation is a concept used to encompass the entire range of wages and benefits, both current and deferred, that owners and employees receive. Total compensation includes all types of employee compensation combined: wages and salary, bonuses, nonwage cash payments, and benefits. For an owner, this includes draw and salary, bonuses, return on capital, return on equity, any matching contributions to a 401(k), deferred compensation, and firm payments toward health care, life/disability insurance, and other benefits.

Total compensation is important in any organization because most employees and many owners do not understand total compensation costs. Consider the following items that often go unnoticed and unappreciated by employees: (1) training costs, (2) advanced-degree tuition reimbursement, and (3) additional time off. The true cost of your total compensation may be even more than you believe it is. This is why firms need to improve communication with employees about the total compensation they receive—not just salaries, wages, bonuses and other obvious benefits.

At the 2004 Workforce Planning and Development Conference, Elliot R. Sussesles, senior vice president of the Segal Company, provided the following information when discussing whether a firm’s total compensation structure supports employees’ perceptions and values:

▮ Employees with a working spouse may view health insurance as less valuable than pay increases or other benefits.

▮ Employees without children may see little value in child-related benefits (dependent coverage, 529 plans, or orthodontia plan).

▮ Employees in single-income households may view job security as more important than pay or benefits.

▮ Employees age 45 and older are usually more focused on retirement benefits than are younger employees.

Our best advice is to review your current range of benefits and the flexibility that employees have in selecting them. Once this is done, we recommend that you create a short document that outlines the firm’s compensation philosophy and guiding principles.

Most major corporations, universities, and other entities share such documents with everyone in the organization, and they provide clarity about the firm’s compensation program and principles. Exhibit 6–2, “Sample Firm Compensation Philosophy and Guiding Principles,” provides an example of one such document.

COMPENSATION CRITERIA

In successful compensation systems, owners know what counts and what does not—with no second guessing.

We selected 18 criteria for our 2006 Compensation Survey and asked firms to identify whether they use each criterion and how important each is (from very unimportant and somewhat unimportant to somewhat important and very important). The results are summarized in Exhibit 6–3, “Compensation Criteria.” Listed below are the top five criteria firms identified as “very important” in determining compensation.

▮ Book of business 26%

▮ Fees collected 25%

▮ Personal billable hours 18%

▮ New business development 17%

▮ Ownership percentage 17%

Even as we realize there can be many different ways to interpret the following, we believe it is helpful to define and discuss each of these criteria. The 18 criteria are listed in the following sections, with our descriptions.

Book of Business

Book of business was rated as the top compensation criteria in our survey. This is not surprising because business development is the lifeblood of any organization, including accounting firms! A book of business can best be defined as revenue for those clients that fall under an individual owner’s billing run. In other words, these are the clients for which an owner has overall responsibility. They may not be the clients the owner actually brought in. In many firms, clients brought into the firm by its rainmakers are often transitioned immediately to more client-service-oriented owners.

The overall dollar amount of an owner’s book of business is important because it is one clear measure of current potential contribution to the firm. The overall dollar amount of the book of business by itself, however, is not necessarily the best criterion for financial contribution to the firm, as we will discuss in the next section.

Client or Book Gross Profitability

We should note that more firms are looking at the profitability of an owner’s book of business in addition to its overall dollar amount. If you analyze gross profitability at the client or book of business level, you may be surprised by your findings. One firm that performed this analysis found that 85 percent of its gross margin came from only 50 of its top clients.

The process is simple. Take a 12-month period (usually a calendar year). For each client, determine the amount of cash that was received and the amount of time (at cost) that was spent on the client. Include owner time in your calculation. This gives you a gross profit figure. To determine net profit, you can simply allocate a general overhead expense to each client.

When considering an owner’s book of business, it is important to understand the following:

▮ Which owner has the most profitable book of business

▮ Which clients are the most profitable for the firm

▮ Which clients lose money for the firm

This can be used not only for compensation purposes, but also for culling the client base in instances where there is more work to do than available time or personnel.

Cross-Selling

Anecdotal evidence suggests that the more services a client uses, the less likely the client is to disengage the firm. Banks discovered this many years ago and do a good job of securing a customer’s checking account, home mortgage, certificates of deposit, and the like. To determine which clients are using multiple services, you can create a simple client matrix within Microsoft Excel that lists client names in Column A and firm services in Row 1. Then, you can simply place an “X” in the appropriate cells.

Fees Collected

Fees collected ranked second in our list of 18 criteria. This is an easy measure to track and is more meaningful than chargeable or billable hours. Fees collected can also be linked to client satisfaction with work product and timeliness of delivery. Clients who are satisfied are more likely to pay quickly and have fewer write-downs and write-offs.

Firm Management

Corporate America recognizes, perhaps to a fault, the value of management. Most CEOs in the corporate world are highly compensated. According to Lawrence Mishel at the Economic Policy Institute, “In 2005, an average CEO was paid 821 times as much as a minimum wage earner.” Last year, according to the Economic Policy Institute, the average CEO was paid $10.9 million a year, or 262 times an average worker’s earnings of $41,861. Now, we do not expect such a gap will soon become prevalent in CPA firms, but it does show the importance of management’s role in any business.

According to John P. Weil & Company, some professional services firms do not recognize the contribution of effective firm management to the firm’s overall success (or lack thereof). In many firms, management is not a factor in compensation. Any organization unwilling to pay for proper management, however, will have little long-term, effective leadership. Effective management, therefore, should be recognized and compensated.

The accounting profession has begun to recognize the need for firm management and leadership. The primary leadership roles in a public accounting firm generally include the managing owner, the executive committee, and department heads (such as audit, tax, and consulting). Their responsibilities include setting the vision and strategic direction, building long-term value, identifying potential new opportunities, engaging in practice development, and creating owner alignment. People in management positions should have a significant portion of their compensation based on firm goal achievement rather than personal goals. By doing this, the firm sends a message to owners that management responsibilities have similar importance as billable hours or client work. Billable hours pay us today while effective firm leadership and management pay us in the future.

Industry Experience and Expertise

As firms begin to specialize, owners who have industry or niche expertise add more value to the firm’s value proposition. There is a wide gap between the tax owner who is a generalist and the tax owner who is an expert in estate planning issues for family-owned and closely held businesses. The first owner is competing against every tax practitioner in the market, while the second has unique and specialized consulting skills that may provide clients with exceptional value-added advice and service. Owners who have experience in and deep knowledge of an industry are usually more valuable to the firm and its clients than the generalist owner.

Managed Charged Hours

Building and managing a book of business is critical to a firm’s current well being and long-term success. It may, over the long run, be even more important than bringing in new business. Let us explain.

Owner A is the classic rainmaker. She loves bringing in business and then going on to the next exciting opportunity. The firm has been impressed with Owner A’s ability to bring in new clients but has never analyzed how profitable these clients actually are.

Owner B is the classic minder. He does not bring in a lot of new clients but is outstanding at expanding business to his current client base. This work is less costly to acquire and keeps other owners and employees busy throughout the year. Let’s also assume this work is more profitable.

Both owners help the firm grow. Over the long run, Owner B’s contribution to net income per owner may be significantly more than Owner A’s.

Owners who increase the hours they manage, either by cross-selling or expanding services to existing clients, should be recognized for doing so. Their work, while often considered less glamorous than rainmaking, is an extremely valuable contribution to the firm. If the firm is unable to nurture and sustain its current client relationships, the job of the rainmaker would be much more difficult.

Mentoring and Training Employees

Those who develop technically competent employees, solid professionals, and future leaders must also be rewarded. Owners who take time and make an effort to mentor, train, and develop others (or develop the systems that support such efforts) must surely be rewarded for activities that build future capacity.

New Business Development

New business is the lifeblood of any organization and keeps a firm vibrant by providing employees opportunities with new and varied types of engagements. Imagine a firm with client attrition that averages 10 percent per year. Assuming this is true, the firm could not exist for long without new clients and new work.

New business development or origination is often recognized by firms as one of the top evaluation and compensation criteria. During the last several years, firms have also started to pay more attention to the profitability of new business as well as top-line revenue. Beyond the above, many firms are striving much harder to ensure that new clients fit an ideal client profile, and as a result, have developed reasonably detailed client acceptance procedures.

Many people believe new business development is an art, but it is also a “science”—a skill that can be learned. There are a number of good business development training programs available to accountants, and The Growth Partnership offers a workshop titled “The Reluctant Salesperson: A Realistic Approach to Practice Development for the CPA .”

Ownership Percentage

Equity owners provide working capital, meet payroll, sign real estate leases, and maintain overall responsibility for firm liability. They should, therefore, be given a certain return for the risks they take. In smaller and younger firms, the founders are indeed entrepreneurs. In larger firms and those that have transitioned successfully from the first generation of owners to the second, the owners are generally less entrepreneurial because they have inherited a well-established business.

The return to which equity owners are entitled for their investment and risk is, of course, open to great debate.

Personal Productivity (Billable Hours and Charge Hours)

Personal productivity is generally evaluated either by the number of charge hours (work in progress) or by the number of billable hours an owner produces. Billable hours are always more valuable than charge hours. Personal productivity, in our minds, is even more complex. Consider the following scenarios; which owner do you believe is more productive?

Owner A has 1,500 charge hours but abuses employees and requires hours of personal counseling by management. Owner B has 1,300 charge hours but trains and mentors employees consistently, participates enthusiastically in change efforts, and serves as a model owner.

Measuring productivity is further complicated by the efficiency with which engagements are managed or the number of clients an owner serves.

Consider another scenario. Again, which owner would you consider to be more productive?

Owner X delegates work to other owners and employees in the firm (that is, leverages). Owner Y, all else being equal, hoards work for himself.

While personal production should certainly be a factor, be sure you understand the real productivity behind (or in addition to) the numbers.

Professional and Community Involvement

Both professional and community involvement can enhance the firm’s image, reputation, and prestige. Participation in professional activities (for example, speaking at an AICPA or state society conference) provides the firm exposure to other professionals. Speaking at, or participating in, civic, charitable, and niche or industry activities provides exposure to potential clients and referral sources. Through these networking activities, firms can also maintain good relations with other firms, identify and recruit future professionals, and serve as good citizens.

Participation in organizations can help an owner develop relationship-building and leadership skills. Personal stature in the community or profession adds to the stature of the firm, and an increase in stature or reputation is often a catalyst for attracting new clients.

Owners who engage in these activities should generally have the agreement of other owners in the firm that there is value in these activities (that is, there is some form of return on investment measurement).

Realization

Realization is the percentage of standard fees on a client engagement that is actually billed after any write-downs and write-ups. Standard (gross) fees are commonly referred to as total chargeable hours at standard billing rates. If Owner A has a billing rate of $225 per hour and spends 20 hours on a client project, the standard fees or gross fees for this project are $5,000. If Owner A decides to bill the client only $4,500, the realization is 90 percent ($4,500/$5,000). For whatever reason, Owner A decided he cannot bill the client more than $4,500. Some firms confuse realization with client profitability. There is a difference.

Seniority

“The older I get, the wiser I am.” Well, that adage may be true—or not. Neither age nor seniority has anything to do with wisdom, and we know it has nothing to do with contributions to the firm. Yes, there are some senior owners who contribute more than anyone else in the firm, but there is no correlation between age or seniority and firm contribution.

In some firms, there is certainly a perceived value in tenure and seniority. Law firms that use a lockstep method of compensation and accounting firms that allocate profits based on points (which usually increase over the years) more heavily reward owners based on longevity.

However, the value of seniority can be difficult to define. Being with a firm for the most years does not necessarily mean an individual owner has the highest value. Rather, we believe the firm should look at the owner’s contributions to the firm over the years:

▮ What has been the owner’s contribution in terms of growth and name recognition?

▮ How has the owner spent his or her years developing new clients and maintaining existing ones?

▮ What has the owner done to enhance the firm’s reputation?

▮ How has the owner helped develop and train younger staff members?

While owner tenure or seniority has had a strong influence on compensation in the past, most new compensation systems downplay this criterion or do not include it as a factor at all. Firms that favor tenure or seniority as a factor in compensation (a bonus distribution) generally have an owner group (or strong subset of senior owners) that may be uncomfortable with annual evaluations based on performance and are generally unable to grow at a fast pace.

Technical Expertise

In today’s environment, technical expertise is a given; it is the “price of admission.” But there are degrees of technical expertise. Is the tax owner with a master of science in taxation (MST) degree worth more than one without such advanced training? Is the owner who becomes the guru in estate tax worth more than the generalist who only completes Forms 1040? There is a real need to recognize such unique and specific competencies and what they mean to the firm’s reputation, image, and economic results.

Specific technical expertise measures include, but may not be limited, to:

▮ Know-what: Degrees (for example, MBA or MST), licensures (for example, CPA or JD), certifications (for example, CVA, CFP, or DABFA), and other education that increases an individual’s technical knowledge and equips him or her to provide a wide array of advice and counsel.

▮ Know-how: An individual with know-how can apply his or her know-what (often referred to as book knowledge) to real-life situations. For example, you can read about sailing all day long, understand all terms and nautical rules, but it is not until you get the boat in the water and begin to tack, come about, or jibe that you can move from know-what to know-how.

▮ Know-why: For long-term success, even know-how is not sufficient. Professionals need to move to the next level, know-why. This requires a professional to understand the interrelationship of the elements of a system. Individuals with a deep understanding of know-why can tell you the consequences of the actions that will likely happen when you change one element of a system long before the final report is presented. Think about the complexity of developing an estate plan and the knowledge required to make sure all pieces of the plan fit and work together.

Technical expertise can also be evaluated by observing and measuring the following owner talents:

▮ Creativity in problem solving

▮ Good oral and written communications

▮ Good on-the-spot judgment

▮ Good analytical skills

▮ Being able to handle complex problems

▮ Being able to meet deadlines

Utilization

Utilization is the amount of time employees and owners are chargeable. Rules of thumb are owners should be chargeable from 50 percent to 60 percent of the time, and employees should be chargeable approximately 70 percent of the time.

The calculation of utilization is quite simple. Divide an individual’s chargeable hours by his or her total hours to determine the utilization percentage. For example, a person who charged 1,600 hours and worked 2,200 has a 72.7 percent utilization rate. You can also measure utilization on a departmental, team, industry, and firm basis.

Utilization was not one of the top five criteria. There is a fatal flaw in putting too much emphasis on this criterion because it uses chargeable time in the calculation. It is an easy criterion to manipulate. An owner merely needs to have a high level of chargeable time rather than billable time to make the utilization percentage look good. This is why firms place more emphasis on net fees collected than on utilization. As the saying goes, “cash is king.”

Other Criteria

There are certainly other criteria firms use in determining owner compensation. Some firms evaluate an owner’s compliance with the firm’s policies. Other firms look at how well the owner gets along with other owners and employees. And still others consider the committees on which an owner has served during the year. Many owner behavioral criteria can often be captured by developing the firm’s core values and measuring how well the owner lives them.

Criteria for Effective Compensation Systems

Exhibit 6–4, “Sample Indicators/Measures of Success,” is a chart we often use in our compensation consulting. It provides a list of leading and lagging indicators that can be used in determining criteria for your compensation system. It is not meant to be all inclusive. We encourage you to look at it and add criteria that may better fit with your firm’s culture.

We asked survey participants two follow-up questions. First, “How satisfied are you with the current criteria?” Second, “How satisfied do you believe your fellow owners are with the current criteria?”

Only 29 percent responded “very satisfied,” and 44 percent said “somewhat satisfied” to the first question. For the second question, only 23 percent answered “very satisfied,” but 50 percent replied “somewhat satisfied.”

Finally, we asked survey participants to indicate which of the criteria should be used in their owner compensation system. Here are the top 10 responses ranked from highest to lowest:

FINAL THOUGHTS

Before we end our discussion about criteria, we want to make one crucial claim. It is a mistake to hold all owners to the same criteria. Each owner in your firm has unique areas in which he or she generally excels. A good compensation system helps you to determine these areas, consider their relative importance, measure their impact, and reward the owner accordingly.

Each owner should be evaluated on each of the criteria based on his or her goals, role in the firm, and fit into the firm’s overall strategy. For some, the highest level of technical competence is expected. For others, it could be mentoring. For others, client development.

Owner A is the great senior practice owner who needs to be good at a lot of things. He or she develops some business but has little firm management responsibilities. Owner B, on the other hand, is the rainmaker. He or she is expected to bring in a great deal of new business but does not manage client engagements or bill much. Owner C is the typical working owner. He or she is a strong technician and has little, if any, firm management responsibilities. The secret is to set expectations based on each owner’s role and then compensate each owner based on how good he or she is in that role.

There are some criteria, however, to which all owners should be held and that should be applied equally, for example, living the firm’s core values and following firm policies. At the end of the day, owners should be motivated to do what they like to do best, as long as it helps to achieve the level of excellence needed in today’s competitive environment.

EXHIBIT 6–1 Robert Half 2006 Public Accounting Salary Statistics

Public Accounting—Audit, Tax, and Management Services (Large Firms) (a)

Experience/Title	2006 Salary Range
to 1 year (b)	$42,750–$52,000
1–3 years (b)	$48,750–$60,000
Senior (b)	$56,750–$75,000
Manager (b)	$70,250–$95,000
Manager/Director (b)	$85,500–$130,000
(a) $250+ million in sales
(b) add 10% for a graduate degree or CPA

Public Accounting—Audit, Tax, and Management Services (Medium Firms) (a)

Experience/Title	2006 Salary Range
to l year (b)	$36,750–$46,000
1–3 years (b)	$43,750–$53,000
Senior (b)	$50,000–$70,000
Manager (b)	$66,500–$83,250
Manager/Director (b)	$76,750–$111,000
(a) $25 to $250 million in sales
(b) add 10% for a graduate degree or CPA

Public Accounting—Audit, Tax, and Management Services (Small Firms) (a)

Experience/Title	2006 Salary Range
to l year (b)	$35,500–$42,500
1–3 years (b)	$39,500–$47,000
Senior (b)	$47,000–$59,250
Manager (b)	$60,000–$72,500
Manager/Director (b)	$71,500–$90,250
(a) up to $25 million in sales
(b) add 10% for a graduate degree or CPA

(Source: 2006 Robert Half and Accountemps Salary Guide)

EXHIBIT 6–2 Sample Firm Compensation Philosophy and Guiding Principles

Eagle & Rice Compensation Philosophy and Guiding Principles: ▮ To attract, retain, reward, and motivate the productivity and commitment of highly qualified employees and owners. ▮ To provide flexibility appropriate to the dynamic challenges facing professionals today. ▮ To help the firm compete successfully for employees with the mix of skills vital to its mission. ▮ To provide a flexible benefits package that allows employees to choose the appropriate benefits for their individual situation. ▮ To embrace a pay-for-performance system of total compensation —We reward outstanding performance. —Base compensation reflects above market average. —Bonuses reflect performance. —Primary responsibility for determining pay rests with you and your supervisor based on achieving goals set forth in your win-win agreement. ▮ Market considerations, overall firm profitability, or regulatory demands may cause the firm to change its compensation and benefits practices. Employees should be aware that their benefits may change from time to time as a result of firm policy decisions.

EXHIBIT 6–3 Compensation Criteria

	Currently Used	Not Currently Used	Very Unimportant	Somewhat Unimportant	Somewhat Important	Very Important
Book of business	44%	35%	4%	5%	24%	26%
Client or book gross profitability	23%	58%	2%	4%	21%	15%
Community involvement	19%	63%	4%	15%	20%	2%
Cross selling	15%	68%	4%	9%	19%	3%
Fees collected	37%	40%	4%	5%	24%	25%
Firm management	43%	32%	3%	9%	40%	13%
Industry experience/expertise	13%	65%	3%	7%	26%	6%
Managed charged hours	30%	48%	3%	8%	28%	13%
Mentoring and training employees	20%	60%	2%	11%	24%	7%
New business development (origination)	40%	40%	1%	7%	23%	17%
Ownership percentage	40%	35%	9%	12%	23%	17%
Personal billable hours	36%	39%	3%	7%	31%	18%
Personal charge hours	32%	45%	5%	10%	26%	13%
Professional involvement	17%	60%	4%	15%	20%	4%
Realization	33%	44%	3%	8%	28%	16%
Seniority	21%	57%	8%	13%	20%	6%
Technical expertise	19%	58%	3%	8%	26%	10%
Utilization	13%	64%	5%	11%	19%	5%

(Source: 2006 Compensation Survey)

EXHIBIT 6–4 Sample Indicators/Measures of Success

Leading Indicators/Measures of Success ▮ Attendance/participation in firm or outside activities ▮ Team player ▮ Meets deadlines ▮ 360-degree employee evaluation (core values) ▮ Technical skill development ▮ Credential/licensure ▮ Coordinates or facilitates staff training ▮ Performs strategic client reviews ▮ Attends client meetings ▮ Gives seminars/workshops ▮ Quality of work ▮ Client satisfaction ▮ Client relationship mgmt ▮ Client retention ▮ Community service/memberships ▮ Manages others ▮ Mentors/coaches others ▮ Responds to RFPs ▮ Helps develop internal systems ▮ Spends significant time learning client needs ▮ Rainmaking ▮ Alone ▮ Together ▮ Total hours worked ▮ Billable hours ▮ Total revenue ▮ Realization ▮ Firm-wide ▮ Office ▮ Engagement or project ▮ Profitability ▮ Firm ▮ Office ▮ Engagement or project ▮ Contribution margin ▮ WIP ▮ A/R (aging) ▮ Cross-sold services ▮ Number of services provided to a client ▮ Net fees realized ▮ Net fees realized per person ▮ Income per shareholder