CHAPTER 9
DESIGNING A NEW COMPENSATION SYSTEM: ATTRACT, REWARD, AND RETAIN TOP PERFORMERS
“While compensation is unlikely to drive performance, inequitable compensation decisions hurt morale and consequently diminish performance.”
—James D. Cotterman
In this chapter we explore a process you can use to design the right compensation system for your firm. We provide you with the process rather than the answer because, as we have noted, there is no single best compensation system for every firm. Before we get into the design section of the chapter, we look at some key learnings about owner compensation. The chapter closes with suggestions on rolling out a new compensation plan, incentive plans, and noncash rewards.
KEY LEARNINGS
We review key learnings with the hope it will help you understand and evaluate your own compensation system before attempting to replace it with a new or improved system.
The Search for the Holy Grail
According to legend, people have been searching for the ideal—the Holy Grail, the Fountain of Youth, El Dorado—for ages, with little or no success. As far as we know, public accounting firm owners have also long searched for the perfect compensation system with limited success. While there are no doubt countless reasons for this lack of success, the primary reason is likely that compensation systems involve human beings. We could say there is no perfect compensation system because there are no perfect human beings, but we believe saying so is an oversimplification.
No matter how mechanical, objective, mathematical, or systematic your compensation system, the human element cannot be removed—in either the system’s creation or owner reaction to its application. Consider the following scenario.
Mary is an owner in an eight-owner firm. She has been an owner for nine years and is a key rainmaker, but not the highest paid owner. John has been an owner for six years and falls in the middle of the owner compensation distribution. John is an outstanding client service owner, but lacks Mary’s rainmaking skills. Both receive significant salary increases (in fact, the two highest increases) for their contributions to the practice. John believes he was justly recognized and compensated, and the increase motivates him. Mary, on the other hand, is somewhat disappointed, and her ego suffers. In her heart she believes she is worth more and wants more.
No compensation system will ever eliminate potentially negative human reaction. The late Don Istvan, one of the best-known consultants to the accounting profession in the 1980s and 1990s, once told us, “A good compensation system will keep most owners happy most of the time.” Hence, it is not unusual that most compensation systems produce disappointing feelings for some of the owners and staff members in any given year.
Aligning Rewards and Culture
An important factor that predicts how well a compensation system will work is how well it aligns with the firm’s culture. When the system rewards behaviors that are contrary to the firm’s core values, it creates a disconnect between what is said to be important and what is rewarded. This often is the start of a dysfunctional firm. For example, a midsized firm has “teamwork” as one of its core values. When it came to compensating owners, however, this value was not recognized. Rather, individual behavior and results were most highly rewarded.
Show Me the Money!
We already shared that no margin means no mission, but it may also mean the difference between keeping and losing good people. Usually it is not the system itself that causes the problem(s). It is the money—or lack thereof. Money can cure many evils in a poor or unfair compensation system. And as long as there is enough to keep everyone happy, many problems remain out of sight.
Managing the Outcome
A compensation system is a mechanism for rewarding individuals by distributing money, generally firm profits. If it were that simple, however, there would not be as many emotional issues as there usually are. A good system helps firm leaders manage the gamut of human reactions and feelings that occur when compensation decisions are made. But how often do you really consider the emotional impact of your compensation decisions on the individual? If compensation is supposed to motivate and reward good performance (encourage productive behavior and outcomes), and discourage poor performance (discourage nonproductive behavior and outcomes), then you must ask yourself, “How well are we doing?”
Here is a real-life example to consider.
A large public accounting firm is able to reduce an owner’s income by up to 15 percent in any given year for lack of performance. Hence, owners who did not perform the previous year experience a decrease in base compensation. However, firm management did a poor job of explaining these compensation decisions because many of the owners were long-time friends. They simply found it too difficult to have an honest discussion about performance.
The firm’s attempt to change behavior by using money as the leverage did not work. Underperforming owners did not understand the message, and they did not know how they could improve. Money alone (or lack of it) is generally not the best or only way to communicate poor performance. You still need to have old-fashioned face-to-face conversations to discuss expectations and help underperforming owners improve.
In “Making Better Compensation Decisions,” James Cotterman, a principal at Altman Weil, Inc., and leading compensation consultant to the legal profession, notes, “While compensation is unlikely to drive performance, inequitable compensation decisions hurt morale and consequently diminish performance.”1
WHAT MAKES A GOOD PLAN
While there is no perfect plan, there are many basic characteristics of a good plan. During the course of our consulting we have noted the following questions must be answered affirmatively to help ensure the firm has a good plan. To how many of them can you answer “yes” when it comes to your current compensation plan?
Is the system fair?
Is it fairly applied?
Have you involved those most affected by the plan?
Does everyone understand how it works?
Does it promote the most profitable work for the firm?
Does it create a one-firm concept rather than silos?
Does it encourage the owners to live the firm’s core values?
Does it encourage everyone to do what’s best for the clients?
Is there some flexibility to reward exceptional performance?
Does it substantially reward performers over nonperformers?
Does it reward for current production as well as building future capacity?
Is the compensation system tied to the firm’s strategic goals?
Does the system usually provide for predictability in total compensation year over year?
Is the system modified from time to time based on the changing needs of the firm?
Will the system keep the firm alive after the retirement of the senior owners?
Every compensation plan should be constructed to help the firm achieve its strategic goals and to attract, reward, and retain the right people. If the plan does not accomplish these two objectives, it needs to be restructured, unless your goal, of course, is to attract and retain average or less-than-average performers. Jim Collins in Good to Great writes, “The purpose of a compensation system should not be to get the right behavior from the wrong people, but to get the right people on the bus in the first place and then keep them there.”2
Public accounting firm compensation plans have changed over the past 20 years or so because the business environment and the workforce have dramatically changed and new technology dominates today’s business workflow. And even though compensation plans have changed, and continue to change, they remain as one of the most difficult systems to change in any organization, especially accounting firms.
Today’s workforce also operates somewhat differently from previous generations. There was a time when the employee and the employer had an unwritten social contract. The employee was loyal to the company and vice versa. Somewhere along the line this social contract was broken. Organizations have less loyalty to employees, and employees are often accused of being loyal only to themselves. If this is true, today’s workforce needs a different kind of compensation program.
In Practice What You Preach, David Maister observed, “The method of compensation is largely irrelevant as a causal factor for high and sustained performance.” He continues to note, “Those who contributed the most to the overall success of the office are the most highly rewarded. Notice that this does not suggest what the pay scheme should be. The determining factor is just whether the people think it rewards the right people.”3
Some of the best practices in designing a compensation system include:
▮ Embrace a total compensation philosophy which reminds employees that their compensation includes a lot more than just base pay.
▮ Define and communicate your compensation philosophy. A focused compensation philosophy answers these fundamental questions:
—What do you want to pay for?
—How do you want to pay for it?
—What is your competitive posture?
—How will you split up the pie?
▮ Tailor the plan to your firm’s culture and values. Too many professional services firms and corporations generally have little or no connection between their stated values and what the compensation plan rewards. Matching organizational values to performance requires a new approach to compensation.
▮ Link compensation to achieving the firm’s vision, mission, and strategy. This involves identifying the firm’s top strategic objectives, defining what they mean in terms of organizational behavior, and designing your compensation plan in a way that rewards and recognizes those behaviors.
▮ Know what creates value in your firm. In accounting firms, value gets created by identifying and satisfying client needs in a profitable manner and by developing processes and systems that improve work flow efficiencies.
▮ Create and hold people accountable to competency maps that outline needed skills and behaviors.
▮ Focus on criteria that improve both top line and bottom line.
▮ Reward skills and behaviors that drive results (for example, developing more efficient processes, training others, billing in a timely fashion). You can only create permanent behavior change by first changing the culture and the environment, then using compensation to reinforce those changes.
▮ Measure and reward individual, team, departmental, and firmwide objectives.
DESIGNING A COMPENSATION PLAN
After you address these issues, you can begin to build the actual compensation plan. Remember, many of today’s workers are often loyal to themselves first and the firm second. Your father’s compensation plan won’t work today. Today’s workforce requires a very different kind of compensation plan. And while firms will design different plans, there are fundamental and foundational principles to which every plan should align. To ensure adherence to the principles of good design, consider the following 12 items.
Ask foundational questions. Before getting too far into the design, ask the following questions:
▮ What is the life of the plan?
▮ Who will be responsible for administering it?
▮ Who will participate in the plan? Just owners, or owners and employees?
▮ How often and when will payments be made?
▮ How will you determine the payout?
▮ How will you measure the goal?
▮ How will you track results?
▮ Will there be minimum thresholds or will it be an all-or-nothing payout?
Ensure the plan is win-win-win. For any compensation plan to succeed over time, it must meet the needs of three critical stakeholders: clients, employees, and other stakeholders. Secondary stakeholders include employees’ family members, vendors and suppliers, referral sources, the community, and so on.
Use both satisfiers and motivators. In the mid 1960s management theorist Frederick Herzberg made a discovery that changed the way in which people understood motivation in the workplace. Herzberg interviewed 200 engineers and accountants and asked them about one positive and one negative work experience they had encountered. He then probed their answers to find out what was behind each experience. Herzberg discovered a group of “satisfiers” that were generally responsible for positive experiences, and a set of “dissatisfiers” that were generally responsible for negative workplace experiences. Satisfiers (base pay, benefits, and so on) allow you to attract and retain people but don’t motivate performance. Motivators (payfor-performance incentives, empowerment, recognition, job opportunities, growth and learning, and so on) drive people to improve performance.
Get owners, employees, or both involved in the design. We like to say, “No involvement, no commitment.” Be sure you provide all owners an opportunity to participate in the design of the plan. By inviting participation, valuing all viewpoints, and brainstorming about the whys and hows, it is more than possible to design a system that is both fair and objective.
Balance rewards for results and effort. While you always want to pay for results, it is also important to recognize effort. Owners who worked hard for results but failed to achieve them based on circumstances outside their control should receive recognition, even if it is not monetary.
Identify measures, define targets, and track performance. Measures need to be identified. For example, a measure could be “new business development.” A target for an owner could be three to five new clients with total revenue of $50,000 to $75,000. Then achievement toward the target is tracked and reported monthly.
Strive to create high trust within the firm. Low trust can kill a compensation plan, and changing compensation plans in a negative or low-trust environment is virtually impossible. The best way to raise trust in an organization, and therefore make needed changes to compensation, is to build personal character and competence within individuals so they can create trusting relationships with each other. Not only must individuals talk the talk, they must walk the walk. This is a case where actions speak louder than words.
Avoid side or one-off agreements. When recognizing and rewarding superior performance, do not have special agreements; they can create different classes of citizens in your firm. Every employee within a specific role should have the same bonus opportunity or potential for similar performance. Superstars generally work well under such a system. Remember, however, one great year does not make a super-star. Over time, a real superstar’s base compensation generally increases substantially over the average performer. In addition, the superstar should receive annual bonus payments far above the average performer.
Communicate, communicate, communicate. Implementing a new or revised compensation plan requires constant and detailed communication. Ensure you allocate sufficient time to involve everyone in the design of the program, explain the program, answer questions about the program, and allow individuals to see how they would have been affected by it had your firm been “on this plan” last year.
Reengage. During the first year, it is necessary to recommit and reengage everyone often. If there are problems with the initial design, acknowledge them and make needed modifications.
Budget for bonuses. There is nothing as disappointing as working hard to achieve goals, meeting the goals, and receiving absolutely no bonus for your efforts. On the flip side, it is difficult for the firm to distribute significant bonus dollars when it has not reached its desired profitability goals. We therefore suggest a modest budget to ensure deserving individuals receive bonuses and deserving individuals receive significant bonuses only to the degree the firm reaches its goals. If all owners and staff in a firm achieve their goals, the financial results generally fall and paying bonuses is not problematic.
Pay for performance. Make sure you separate base compensation from incentive pay. Focus your plan on rewarding and paying for performance, results, and productivity.
ROLLING OUT THE PLAN
Perhaps the best way to implement a new compensation plan is to run the old and new plans simultaneously for a year. You pay based on the old plan, but show employees what they would have earned under the new plan. By using this method you can ensure:
▮ The new plan creates alignment.
▮ You are able to track measures and provide periodic reports.
▮ Communication is timely and on target.
▮ You are able to debug any problems.
Once you unveil the plan, meet regularly and often with employees and owners to make sure people understand the plan as well as the actions they must take to meet the stated goals. As you gain experience with the new plan, ask yourself the following questions:
▮ Are we seeing the right behaviors from employees and owners?
▮ Is overall productivity improving?
▮ Is owner and employee morale improving?
▮ Are we on track to achieve our goals?
▮ Are we gaining alignment with key stakeholders—employees, clients, and owners?
INCENTIVE PLAN SUCCESS FACTORS
A recent survey by Meek & Associates, Strategic Compensation Consultants, asked 312 companies about their use of incentives and bonuses. The four most successful incentive plan practices, as reported by these TEC, Inc., members, were:
▮ Linking incentives to the company’s business results
▮ Tying the plan to performance (quantitative and qualitative)
▮ Communicating as much and as frequently as possible
▮ Involving employees in the process
The four biggest mistakes in incentive plan design and implementation were:
▮ Insufficient communication and feedback
▮ Lack of alignment with the business strategy and objectives
▮ Using discretionary measures
▮ Setting unrealistic goals
When asked what they would do differently the next time around, TEC, Inc., members responded most often with:
▮ Tie incentives to results and performance
▮ Communicate, communicate, communicate
▮ Pay out more frequently
▮ Share financial and business information4
INCLUDE NONCASH REWARDS
While cash will always be king, you should also provide your people with noncash rewards and recognition. These are important elements of your overall compensation program. The best way to find out what is important to your people is simply to ask them. This can be done through surveys, focus group meetings, individual interviews, or a combination of these methods.
You will find a wide range of ideas and wants. The best approach is to offer a number of choices rather than just one or two. Examples follow.
▮ Many firms hold a monthly reward ceremony. The important thing about this event is not so much the actual rewards given, but the individual recognition. Make sure you take time to tell a story about why employees receive these rewards. The more personal you can make it the better.
▮ Employees should be able to recognize and reward each other as well as owners. This is especially critical when trying to change firm culture. You want employees and owners to acknowledge others, especially those who exemplify your core values.
▮ Consider changing the noncash rewards every year. Always getting the same reward does not create new excitement. You may also want to consider different reward tiers.
▮ Finally, there are two words not heard often enough in accounting firms: thank you. You can get a lot of mileage from merely saying “thank you” when people do a good job.
FINAL THOUGHTS
In “Follow the Money—the Evolution of Owner Compensation Systems in Law Firms,” Blane R. Prescott, a Hildebrandt International consultant, noted, “Almost all systems produce disappointing results at some time, so most firms are always on the lookout for ways to improve the process, to discover another system that is better or easier, or one which prompts fewer negative reactions among owners. The desire for a better system is therefore both natural and understandable, yet many firms would be well served to understand this simple rule of thumb: There is no such thing as a perfect owner compensation system, and just because the one being used occasionally fails, it may be closer to perfect than one might realize.”5