Compensation Committee Horror Story

This story is real.  Some minor facts have been changed to protect the innocent, but the main points illustrated are based on actual experiences.

Democracy is a good thing.  But like most good things, if taken to the extreme, the results can be disastrous.

To many, it’s almost impossible to separate “partnership” from “democracy.”  Many partners in CPA firms believe strongly that the firm should be managed in a highly democratic manner.  They often feel that being a partner entitles them to be “involved” in managing the firm and making decisions.  They feel that this is the democratic way.

One area where the democracy mindset is tinkered with is when a firm adopts the compensation committee (CC) approach to allocating partner income (there are many other examples).  This is a tall leap for partners to take.  They are asked to entrust the most significant and sensitive aspect of being a partner – their compensation – to a small group of partners who function as judges.  They are told that if the partners don’t trust the judges, the system won’t work.

I have seen many firms who move to the CC system doggedly try to retain some semblance of democracy by adopting a rule that every partner eventually gets a chance to serve on the committee.  This is done by limiting the re-election of committee members.

Let me illustrate how this can backfire. Many of my clients ask me to attend their CC meetings for the first two or three years to keep them on track.  One firm that I worked with did a great job of objectively evaluating the performance of each of their eight partners.  During my first year with one firm, I witnessed the CC doing a fabulous job of evaluating each partner’s performance.  One of the partners had a terrible evaluation and actually had his pay reduced as result.  This partner was as close as one can possibly get to being fired.

Lo and behold, in the second year of the CC at this firm, this probationary partner was elected by the partner group to the committee to replace a member who was required to step down.  How crazy is that?

The moral of story is this:  The partners have to trust the judges for the system to work.  But in order to trust the judges, all the judges need to be credible to the other partners.

My advice to firms is to allow CC members to serve an unlimited number of terms, thereby resisting their democratic urge to give everyone a chance. Most firms have at least one partner who is not viewed as credible by the bulk of the partners.